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Gift Tax: When receiving a gift becomes taxing…

, October 14, 2016, 0 Comments

gift-tax-income-tax-act-marketexpress-in‘ What is bought is cheaper than a gift ’, goes a Portuguese proverb. In the realm of Indian taxation, nothing could be further from the truth; for under the Income Tax Act, 1961 (“IT Act”), certain gifts received by individuals, partnerships and companies are regarded as income, and taxable in the hands of the recipient of such gift. However, the Indian Revenue authorities have often sought to tax transactions, which may otherwise not be taxable at all.

We will examine some such scenarios, and observations of judicial authorities.

Taxation of income from other sources under the IT Act

Section 56 of the IT Act, dealing with income from other sources (“IFOS”) is a ‘residuary’ provision i.e. incomes that do not otherwise fall under any of the other four heads of income i.e. salaries, income from house property, capital gains and business income, are taxed as IFOS. Incomes which typically fall under IFOS inter alia include dividends, interest, receipt of cash or property (including shares) at nil or inadequate consideration etc. Thus, if an individual receives money in excess of INR 50,000[1] or property at nil or inadequate consideration, she may be liable to tax at 30%. Similarly, if a closely held company receives shares from another closely held company at nil/inadequate consideration, such receipts will also have similar tax implications for the recipient company.

Is company capable of “love and affection”?

One of the primary questions is whether an artificial person like a company can indeed “give” or “receive” gifts, since a gift is linked to “love and affection”. In CIT v. KDA [2], the Tribunal examined whether companies were competent to give and receive gifts. In this case, KDA was in receipt of cash from its shareholders, which was in the nature of voluntary receipts[3]. As per the IT Act, income is taxable only if it falls under any of the specified heads of income. Since gift received was not in the nature of salary, income from house property, business income[4] or capital gains[5], it cannot be taxed under those heads of income. The residual IFOS clause taxes revenue receipts and not capital receipts. Moreover, IFOS provisions under the IT Act specifically cover the instances of taxable ‘gift’ and if it does not fall within the ambit of those specified instances, such ‘gift’ cannot be taxed.

On the question of a company’s “love and affection”, the Tribunal relied on D.P. World Pvt. Ltd. and Redington (India) Limited, wherein it was held that companies were competent to make and receive gifts; natural love and affection were not a necessary requirement. In fact, the only requirement for a company to give gifts is that the respective Memorandum and Articles of Association must authorize the company to give such gifts. The gift will also not constitute unexplained cash credit, if the taxpayer can explain who has given the gift and its source for the giver. Thus, in the instant case, the receipts from the shareholders were held to be not taxable.

A question that arises is on the taxability of amounts received under “crowdfunding”[6]. If the recipient of the crowdfunding is an unlisted company, and the funds are received towards the issue of shares/debentures, the amounts so received may not be taxable, provided the amount received does not exceed the fair market value of the shares. The SEBI Consultation Paper on Crowdfunding in India (“CP”) has clarified that taxation of funds raised through crowdfunding shall be as per provisions of IT Act as applicable to unlisted companies raising funds through equity, debt or AIF’[7]. However, what happens where the crowdfunding is through small donations from individuals, who donate because they ‘believe in the cause’ of the unlisted company?[8] Since no “shares” are received, based on KDA, will the amounts received not be taxable in the hands of the company? Unfortunately, it may not be easy to determine the source of crowdfunding since the funds are typically solicited by a crowdfunding platform, and the platform may/may not be aware of the identity of donors/ or their source of funds. So, could such donations risk being ‘unexplained cash credits’?

Are bonus shares a “gift”?

Another important question is, whether bonus shares received by a shareholder are liable to tax. In the case of Dr. Rajan Pai[9], the taxpayer received equity shares from MCo, as bonus, against shares he already held. The Revenue authorities alleged that since the taxpayer had not paid any consideration for the bonus shares, the FMV of such bonus shares was taxable as IFOS.

A bonus issuance involves the capitalization of part of the company’s reserves, without creating any new asset for the company. Further, a bonus issuance reduces the value per share of the shareholder, though he typically receives bonus shares pro rata to his existing shareholding. Thus, the Tribunal held that the shares were not received for ‘nil’ or inadequate consideration. In Sudhir Menon HUF, the Tribunal had noted that a bonus issuance does not increase or decrease a shareholder’s wealth, which remains constant, and drew an analogy with somebody exchanging a one thousand rupee note for two five hundred rupee notes to drive home this point. The Tribunal noted that only where a shareholder receives any shares in excess of his proportionate entitlement and to the detriment of other shareholders, can the value of such additional bonus shares be taxed as IFOS.

Since Dr. Pai received only bonus shares proportionate to his stake in MCo, and had not received any asset without or for inadequate consideration, it was held that he was not liable to tax.

While a gift may not often be a blessing given the tax implications for the recipient, not all gifts are liable to tax. Nevertheless, it is best to exercise caution so that the recipient is not caught unawares, and ends up having to pay more money as tax than on the actual purchase of the gifted item.

[1] Initially, the threshold limit was INR 25,000.
[2] [2015] 57 284 (Mumbai – Trib.)
[3] Shareholders donated dividends (that had already been taxed) received by them from another company.
[4] Taxpayer is not engaged in the “business” of receiving gifts from corporate bodies, for the same to be characterized as business income.
[5] A gift has no relation to any capital asset and hence cannot be considered as a capital gain.
[6] Assuming there are no restrictions from a regulatory perspective.
[7] At page 62 of CP.
[8] CP does not discuss this type of funding.
[9] ITA 1290/Bang/2015 dated April 29, 2016.