Impact on Gift of Shares by Companies and Legal Entities

Section 45 of the Income Tax Act, 1961 stipulates that any profits or gains arising from the transfer of a capital asset shall be charged under the head "capital gains". However, section 47 of the Act provides exceptions, specifying transactions that do not constitute a transfer for the purpose of capital gains taxation under section 45. Notably, section 47 states that the transfer of a capital asset under a 'gift or will or an irrevocable trust' is not considered a transfer. Consequently, the transfer of capital assets through a gift is not subject to capital gains tax under section 45 of the Act.

In cases where non-individual entities such as corporates or trusts gift shares, tax authorities have argued that such gifts are a deliberate attempt to avoid capital gains tax. They contend that such transfer of shares by corporate entities cannot qualify as 'gifts' under section 47(iii) since they lack the element of 'natural love and affection'. In contrast, taxpayers have argued that the specific provisions of section 47(iii) exempt gift of shares from capital gains tax, emphasising that the Act does not prescribe the existence of 'natural love and affection' as a prerequisite for gifting shares.

The Courts have delivered conflicting decisions on this matter, resulting in varying interpretations.

Recently, the Bombay High Court in the case of Jai Trust v. Union of India[2024] 160 taxmann.com 690 ruled that shares transferred by a Trust by way of gift should not be subject to capital gains tax.

Earlier, in the case of Asian Satellite Broadcast (P.) Ltd. v. ITO[2020] 119 taxmann.com 481/[2021] 276 Taxman 316/[2020] 428 ITR 327, the Bombay High Court held that transfers of shares without consideration constituted valid and genuine gifts, thereby exempting them from capital gains tax.

Similarly, the Gujarat High Court, in Prakriya Pharmacem v. ITO[2016] 66 taxmann.com 149/238 Taxman 185, interpreted section 47(iii) of the Act to exempt any transfer of a capital asset as a gift from capital gains tax.

In contrast, the Madras High Court in Pr. CIT v. Redington (India) Ltd. [2020] 122 taxmann.com 136/[2021] 430 ITR 298 took a different stance, emphasising that inter-company transfer of shares without consideration could not be automatically treated as exempt under the "gift" provision of section 47(iii). The Court laid special emphasis on the importance of examining the facts, documents, and the intention of the taxpayer at the time of the transaction.

Additionally, the Authority for Advance Rulings (AAR) in Orient Green Power Pte Ltd., In re [2012] 24 taxmann.com 137/210 Taxman 339/346 ITR 137 (AAR - New Delhi) characterised inter-corporate gifts as 'strange transactions' and suggested that such transactions may not be eligible for exemption under Section 47(iii),which specifically covers gifts made by individuals and Hindu Undivided Families (HUFs).

Proposed amendment and its implications
The Finance Bill, 2024 aims to resolve this issue with a specific amendment that states that transfers of capital assets under a gift, will, or irrevocable trust by individuals and HUFs only shall not be considered as 'transfer'. This proposed amendment is set to take effect from 01 April 2024. Therefore, any transfer of shares by way of gift by a company or any other legal entity (on or after 01 April 2024) will be considered a 'transfer' and consequently subject to capital gains tax.

This amendment is poised to significantly impact wealth transfer strategies, particularly those utilising the gifting of shares by companies, private trusts, and similar entities for tax efficiency. It is expected to strengthen the position of tax authorities while examining or litigating past gift transactions as they can argue that the intention of the legislature was always aimed at excluding legal entities from the purview of section 47(iii) of the Act. Therefore, ongoing corporate structuring exercises that involve the gift of shares by a company or other legal entities will likely require reassessment in the light of this amendment.
 

Source:-      Taxmann