How does a family settlement resolve disputes within joint family businesses?

India is known for its diverse culture, which includes a strong tradition of joint families. Further, the joint family concept in India is not limited to living together in a family house, it extends to many more things including owning properties jointly, conducting family businesses jointly in an all-inclusive manner, etc.

Like the head and tail of the coin, combined living, joint ownership of family properties and joint conducting of family businesses have pros and cons in social, sentimental, commercial, and other aspects, hence at times, families need to take certain measures to preserve family values, properties and harmony.

In spite of these measures, conflict in the family may still arise due to overlay of personal dynamics over the commercial focus and resolution of the conflict is utmost important for the families to protect the family harmony and business interest.

Family settlement or arrangement is one of the ways to resolve such disputes by defining the clear rules regarding the management of business and/ or ownership of the assets which include business as well as personal assets. Family settlement would generally lead to a split of business and/ or the assets to avoid overlap of managerial role and ownership over the assets and provide independence to each family.

The term ‘Family Settlement’ is not a defined term under any statute including the Indian income-tax law or succession laws of India. However, one may be curious to know what the term settlement indicates. Is it a settlement of a dispute or a possible dispute?

Key essentials of family settlement to have a legally binding effect on the parties are:

• It should be for the benefit of the family. ‘Family’ here has a broader meaning than lineal ascendant, descendants or blood relatives. It could include extended families like cousins.
• It should be transparent and framed with the right intention and should not be driven by any fraud or coercion.
• It should be for the settlement of present or future disputes by equitable distribution of family property amongst various families/ members.
• There should be the existence of antecedent title (pre-existing rights) in the property.
• It should be meant for the preservation of family property, peace and reputation of the family.
• It is being executed to resolve a dispute or to avoid a potential dispute.

The family settlement would generally lead to exchange of assets amongst the family members and one of the main issues under evaluation would be the income tax implications on such transactions. In absence of any specific provisions under the taxation laws, the taxability of assets transfer under the family settlement has been a matter of dispute.

The courts or tribunal have in the past ruled that the exchange of assets amongst family members under a family settlement would not trigger a capital gain tax because transfer or exchange of properties are happening due to pre-existing rights of family members and hence it is not akin to ‘transfer’ of a capital asset.

The taxability of such transfer of assets has to be determined based on the facts of each case and transfer of assets under the garb of family settlement would not get immunity from the tax and courts have ruled that in these situations, exchange of assets is subject to capital gains.

It has also been noted that the family’s assets are sometimes owned or held in the corporate entities and transfer of the assets by these corporate entities to family members may not get immunity from the capital gain tax. The settlement of these assets needs to be structured to achieve tax efficiency.

Many big business houses and conglomerates have adopted family settlements to preserve the dignity and honour of the family. At times, improper planning, cross transfers from corporate entities to family members or lack of robust implementation/ documentation can hit them hard when challenged in the courts.

‘Prevention is better than cure’ is an age-old tried and tested phenomenon which is being followed by families as few large families or big business houses have started adopting succession planning for their family and business assets and at times careful demarcation of assets is made amongst siblings or even in the same stripe of family too to avoid future disputes.

Nowadays, families have started creating a family charter which though not a legally binding document but provides a framework to the families and guide them to follow the defined rules and principles in order to resolve the conflicts in an amicable way.

Anant Jain, Partner, Legacy Growth and Rupali Ashar, Associate Partner, Legacy Growth