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13 June 2019
Wealth-related disputes are common – even when family and relationships are valued over material needs. As family businesses and relationship circles get larger and more complex, parties often seek to separate commercial control, ownership and interests and achieve greater independence. This brings to the fore the significance of family settlements, which allow families to achieve these objectives amicably while preserving their values and honouring the wishes of all family members.
Family settlements serve a dual role: the distribution of wealth and the allocation of different business lines among family members.
Indian law attributes no legal definition or form to the concept of family settlements. However, the courts do recognise family settlements and have generously interpreted them by attributing a wide scope of meaning to the term 'family'. In general, any person with a remote antecedent title to a family's property can participate in a family settlement.(1) The courts have also acknowledged antecedent titles in favour of outsiders based solely on the fact that at least one family member relinquished their claim in such outsiders' favour and recognised them as the sole owner of the subject property under a family settlement.(2)
Family settlements are rarely invalidated, as the courts accord sanctity to their principal objectives of avoiding disputes and ensuring cordial family relations.(3) Family settlements are likened to agreements under the law. Hence, they must satisfy all of the requirements of a legally enforceable agreement, such as the absence of fraud, undue influence or coercion. This is also why settlement memoranda cannot provide for future transfers which are contingent on the survival of certain family members until such future time, as uncertainties render agreements void. Under common law, oral agreements are enforceable. Accordingly, while it is advisable that family settlements be in writing, this is not a requirement.
While family settlements are subject to minimal judicial interference and considered to be "governed by a special equity peculiar to themselves",(4) they will be enforced only if they are executed in good faith. This implies that the distribution of property among family members under a settlement should be fair and equitable. The good-faith condition does not even require that:
The mere existence of legitimate disputes, existing or potential, which may or may not involve legal claims, will satisfy the criterion.(5) Other points of consideration regarding the good-faith criterion are whether an agreement:
There is no specific tax exemption for income received pursuant to a family settlement. The courts have generally taken the view that:
Accordingly, the courts have not viewed family settlements as transfers subject to capital gains tax in the hands of the transferor. This is likely due to the voluntary nature of family settlements, which implies that persons who receive property (in cash or in kind) are unlikely to receive more than they relinquish. Thus, the provisions regarding the receipt of property without adequate consideration or consideration in excess of the value surrendered do not apply in the context of family settlements. However, this interpretation may not apply where a transfer pursuant to a settlement is undertaken by a company (ie, family business) or another third party and not by family members, who would be the only parties to the settlement.(7)
Further, as regards tax in the hands of the recipient under Section 56(2)(x) of the Income Tax Act, it must be noted that this provision is an anti-abuse rule which was introduced to cover property which is transferred under the garb of a gift for inadequate consideration. Since family settlements have been judicially recognised as a valid means of arranging a family's affairs, the anti-abuse rule should not be triggered. It has been established that the Gift Tax Act 1958 – the abolition of which made way for the insertion of the anti-abuse rules in Section 56(2) of the Income Tax Act – excluded family settlements and partitions from its scope.(8) In any case, Section 56(2) contains a carve-out for gifts made to family members (ie, 'relatives', as defined in the provision). The applicability of the anti-abuse rule may need to be tested where the recipient family member falls outside the defined scope of 'relatives'.
While there is no legal requirement for a written family settlement document to be registered, this is generally predicated on whether the settlement memorandum:
If the former applies, the memorandum will have to be registered.(9) Oral family settlements bypass any registration requirements; however, such settlements will need to be corroborated with other evidence if their existence needs to be proven in court. Documents which should have been registered but were not are usually not permissible as evidence in court. However, the Supreme Court recently allowed an unregistered memorandum of family settlement (which conveyed title and was thus compulsorily registrable) as corroborative evidence. The court went on to hold the memorandum against a family member who did not refute its contents, but assailed it solely on the point of non-registration.(10)
Family settlements are a useful tool for amicably distributing family wealth without having to engage the courts. They serve many more purposes than wills, as they effect a contemporaneous transfer of family property, whereas wills are executable only on the testator's death. Further, the conundrum posed by probate is eliminated through a family settlement. Depending on the family's needs, it would be advisable to implement a good succession and estate planning structure through a combination of:
A carefully structured estate planning device, comprising of a combination of wills and trusts, would need to address the issue of estate duty on the passing away of the testator. This is an important consideration in view of the fact that estate duty may be reintroduced in India at some stage.
In essence, family settlements are a mode of financial planning that achieve the distribution of family wealth through agreement, mutual understanding and consideration. The Indian courts appear to want to facilitate and implement family settlements and avoid protracted litigation among family members. Families with businesses and a large portfolio of joint assets are well advised to consider family settlements as part of their estate planning.
For further information on this topic please contact Daksha Baxi or Sanjana Rao at Cyril Amarchand Mangaldas by telephone (+91 22 2496 4455) or email (firstname.lastname@example.org or email@example.com). The Cyril Amarchand Mangaldas website can be accessed at www.cyrilshroff.com.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
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