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www.livemint.com10 MONDAY, NOVEMBER16, 2009,DELHI

Management mint

GROUNDRULES | KETAN DALAL & VISHAL SHAH

Family arrangements: outside the tax net?

Indian businesses have, typi-cally, been family-owned. Theownership and, in most cases,even the management of thesecompanies are often in thehands of family members. Obvi-ously, as one generation pavesthe way for the next, there arisesa need to work out the rights ofthe respective family constitu-ents. This takes the form of afamily arrangement.

Family arrangements havenot been defined under any law.Typically, this involves the work-ing out of the management and/or ownership rights in the com-mon family property, either fol-lowing or in anticipation of a

dispute or to maintain harmony.Given various (in)famous prece-dents, a family arrangement isgenerally documented in a for-mal contract or a memorandumof understanding. At times, afriendly intermediary takes upthe onus, in a fiduciary capacity,to arrive at the distribution planas regards the common familyproperty and, thereafter, distrib-ute the same among the respec-tive family constituents.

The actual realignment couldtake one of two formsmereseparation of managementrights with common ownership,or separation of ownership

along with management rights.While mere reallocation of man-agement rights should not giverise to tax implications, a reallo-cation of ownership in the fami-ly property, say, shares or im-movable property, could involvea transfer and, hence, act as apotential tax trigger.

Under the Income-tax Act (I-TAct), a transfer of capital assetgives rise to capital gains in theabsence of a specific exemption.

While transfers pursuant to in-heritance or will are specificallyexempt, the I-T Act does notspecifically exempt transfers un-der a family arrangement.

However, Indian courts haveconsistently taken a positionthat a bona fide family arrange-ment should not be regarded asa transfer but a mere workingout of the rights of the familymembers in the common familyproperty, which always existed.

In a recently reported judge-ment of the Karnataka highcourt, in the case Sea Rock In-

vestment Ltd (317 ITR 253), in-

volving a family arrangement ofthe Manipal Pai group, the issueagain came up for consider-ation.

Key ingredientsThe courts have held that un-

der a family arrangement, thereis no transfer of property by onemember to another and it is justan arrangement by which eachmember takes the share of fami-ly property by virtue of his/herantecedent title. As to whether atransfer falls within the ambit ofa family arrangement (and,therefore, out of the tax net), thecourts have consistently evaluat-

ed three ingredients: family,property and dispute.

Family: A family arrangementnecessarily needs to be amongfamily members, and not withoutsiders. The term family hasnot been defined under any law.However, the courts have gener-ally held that the term has to beunderstood in a wider connota-tion. A common tie of relation isenough to bring a person withinthe fold of a family. Also, the ex-istence of legal/succession rightto the family property is not a

prerequisite to determinewhether a person is a familymember.

Property: The family arrange-ment should be for working outthe rights in the family property.Typically, common property or

joint property in the family isconsidered for the purpose offamily arrangement. Individualor self-acquired properties aregenerally not considered unlessantecedent title, claim or inter-est in the property is shown tobe in existence. In essence, anantecedent title of the partici-pants in the subject property isthe guiding factor for evaluating

a bona fide family arrangement.It is, however, not necessary

that every party taking benefitunder the arrangement mustnecessarily have, under the law,a claim to the property. It suffic-es if the parties are related toone another and have a possibleclaim to the property or a claimor even semblance of a claim onsome other ground such as, say,affection.

Dispute: Normally, a disputeis a prelude to a family arrange-ment. However, a pre-existingdispute is not always necessary.So, a bona fide arrangement inanticipation of a plausible dis-pute and to maintain harmonyhas also been held to be a validfamily arrangement.

Not a giftA family arrangement needs

to be distinguished from a vol-untary transfer without any con-sideration, that is, a gift. Thus,the Gauhati high court in Ziaud-din Ahmeds case (102 ITR 253)had held that a receipt of family

property at less than adequateconsideration, pursuant to afamily arrangement, cannot betaxed under the erstwhile gift taxlaw, which sought to deem suchreceipt otherwise as a taxablegift. Interestingly, the recentlyamended section 56 of the I-T

Act seeks to tax similar receipt ofproperty (including shares) fornil or less than adequate consid-eration (a la gift) in the hands ofan individual. While receiptfrom relatives is not covered,family arrangements, per se,should also not fall within theambit of section 56, relying onthe above case.

Sea Rock judgementIn this case, the shareholders

of the assessee company (SeaRock Investments Ltd) werefamily members of the ManipalPai group. There was a disputeamong the members, and thedispute was referred to arbitra-tion. According to the terms ofthe arbitration award, the asses-see company had to transfercertain investments (shares in afirm) to certain family membersfor an agreed consideration.

The company argued that thetransfer of shares should not betreated as a taxable transfer asthe transaction was undertakenpursuant to a family dispute set-tlement in terms of the arbitra-tion award. The assessing officerdid not accept the transaction asfamily arrangement as the trans-feree assessee company wasseparate from it shareholdersand it had actually received con-sideration for the transfer.

The high court held that theassessee company was a sepa-rate legal entity; thus, eventhough the shareholders weremembers of a joint family andthe transfer by the company wasin settlement of a family dispute,the transfer cannot be said tohave been pursuant to such afamily arrangement as the

shareholders did not have a di-rect legal right on the invest-ments held by the assessee com-pany, which were the subjectmatter of the transfer. Further,the assessee company, havingreceived consideration for thetransfer, should be held liablefor the capital gains. It seemsthat had the transfer been by thefamily members, the transfer

would not have been liable tocapital gains.

Incidentally, in this case, thetaxpayer had also argued that ithad not received any consider-ation (which aspect is not veryclear) and, hence, on that point,

the case had been sent back tothe tax tribunal for a fresh adju-dication.

ConclusionIndian courts have consistent-

ly held a family arrangement tomerely represent the workingout of the rights in the commonproperty, between the familyparticipants and, hence, not ataxable transfer.

The Sea Rock judgement,while acknowledging the aboveprinciple, held that since the re-alignment was effected for aconsideration through thegroups holding company,

which is a separate legal entityfrom the shareholders, it wouldnot fall within the ambit of afamily arrangement. Now, it isnot uncommon for promotergroups to hold investmentsthrough private holding compa-nies. A realignment of owner-ship under a family arrange-ment may thus entail transfer ofshares of such a holding compa-ny by the individual participantsbetween themselves or transferof investments by the holdingcompany itself. Undoubtedly,even the latter transfer is, insubstance, part and parcel of,and to give effect to, a family ar-rangement and, respectfully,

should also be out of the tax net.The Sea Rock judgement, to thatextent, merits reconsiderationon this principle.

Interestingly, the proposed di-rect tax code (DTC) has widenedthe definition of the term trans-fer to include any disposition,settlement or an arrangement; itremains to be seen whetherDTC would overturn the settled

judicial thinking on the subject.Ketan Dalal is executive direc-

tor and Vishal Shah is associatedirector, Pricewaterhouse-Coopers. Your comments and

feedback are welcome atgroundrules@livemint.com

mintRealignment ofownership mayinvolve transfer

of shares from aholding co; thisshouldbeexempt

Write to Jack & Suzy

Jack and Suzy are eagerto hear about your careerdilemmas and challengesat work, and look forwardto answering some of yourquestions in futurecolumns. Jack and SuzyWelch are the authors ofthe internationalbest-seller, Winning. Mintreaders can email themquestions atwinning@livemint.com.Please include your name,

occupation and city.Select questions will beanswered.

PINK SLIP CONUNDRUM

3 mistakes to avoid when letting someone go

F iring someone is awful,both for the person do-ing the firing and, obvi-ously, for the person beingasked to leave. Most goodmanagers find the actual deedincredibly difficult. The per-son being let go might be hav-ing the worst day of his ca-reer.

So how do you manage aparting of ways with as littlepain and damage as possible?

The answer is pretty straight-forward: Managers need to ac-cept that letting people go is aprocess that they must fullyown and pay careful attentionto several dos and donts.

Usually, the choice to firesomeone for non-performanceisnt black and white, sinceprecisely who did what and

what went wrong in the lead-up to the finale can be un-clear. For this reason, manag-ers often get firings wrong inone of three ways:

1. Moving too fast: Take thecase of a friend who worked ata small but expanding compa-ny where, as with many com-panies that size, mediocreperformance was generallytolerated in the name of con-

geniality. When my friend waspromoted to head a 60-personunit, she soon realized thatthe man in charge of distribu-tion, Richard, could not

handle the increasingly com-plex logistics. To exacerbatematters, Richard constantlychallenged her authority.

My friend addressed theseshortcomings with Richard, tono avail. Finally, an importantcustomer called to complainthat his shipment was a weeklate. My friend had had it.Richard had to go.

To many, including Richard,the decision came as a sur-

prise. Some staffers felt thathe had not been given enoughwarning and they complainedthat they could no longer trusttheir boss or the organization.

It took my friend aroundthree months to restore equi-librium and get her unit mov-ing again.

2. Not being candid enough:Say youve got a long-timeemployee named Gail, whocant reach her sales quotasno matter how hard she tries.Every time you try to tell herhow badly shes doing, shesso cheerful and oblivious that

you end up hiding your nega-

tive feelings behind a mixedmessage about workingsmarter. The situation culmi-nates when Gail really screwsup, and you impulsively fire

her. Shocked, she reminds youof all the positive feedback

you have given her over theyears, and ultimately leavesangry and bitter.

This may not be the last youhear of her. Every employee

who leaves continues to repre-sent your company. For thenext five, 10 or 20 years, they

will either bad-mouth orpraise your organization.

3. Taking too long: The third

mistake occurs when a firinghappens too slowly. Everyoneknows that a person is aboutto be fired, including the per-son himself, but the boss

waits a long time to pull thetrigger. The result is enor-mous awkwardness in the of-fice that can lead to a sort ofparalysis.

Why do bosses allow this tooccur? Well, firing is so toughthat no one likes to do it, andso the event often gets de-layed. But sometimes in thissituation a manager lets anemployee twist in the windbecause he wants the victimspeers to see the necessity ofthe decision. In a way its cru-el, but most bosses wouldrather be known as carefulthan quick on the trigger.

If there are so many waysthat firing can go wrong, howdo you avoid making mis-

takes?1. No surprises: Very simply,

a good performance evalua-tion process informs and pre-pares people for whats aheadin the fairest, most open waypossible.

If people know where theystand, no one actually getsfired. Instead, when things arenot working out, there is even-tually a mutual understandingthat its time to part ways.

In some instances, it cantake a couple of years for theendgame to become clear toeveryone, but along the way,there will have been manycandid conversations aboutperformance and career goals.The possibility of parting ways

will have been raised and dis-

cussed openly.2. Minimize humiliation: Fora boss, finally delivering thebad news elicits relief. Itsover, you tell yourself. I did

it kindly, and now I can focuson other work.

However, your employee isprobably pretty upset. If

youve done everything right,he wont be surprised, but hemay still be feeling hurt.

The next day and until hedeparts, you must make surehe doesnt feel like an outcastin a leper colony. Build up hisself-confidence. Let him knowthere is a good job for him outtherea job that bettermatches his skills. You mayeven help him find it. Yourgoal for the fired employee isa soft landing wherever hegoes.

Firings are an unfortunatereality of business. Still, if youhandle them right, they can atleast be tolerable for the peo-ple involved. When its time tolet someone go, do it right. Nosurprises. No humiliation.

2009/THE NYT SYNDICATE

Adapted from Winning

(HarperBusiness Publishers,2005) by Jack Welch with SuzyWelch.)

Management can makethe landing softer byensuring that thereare no surprisesand no humiliation

WINNINGJACK & SUZY WELCH

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