Gift of Brand to Private Trust – Tax and Related Issues

(Originally Published on Taxsutra: https://www.taxsutra.com/dt/experts-corner/gift-brand-private-trust-tax-and-related-issues)

The Mumbai Income Tax Appellate Tribunal (‘ITAT’) vide an order dated November 25, 2021 [TS-1092-ITAT-2021(Mum)] had held that a gift of brand by Essar Investments Ltd to the corpus of a private irrevocable Trust (Balaji Trust or ‘Trust’) was not a taxable event.

Background

The background of the matter is that the Trust was created for the sole and exclusive benefit of the Ruia family in 2012. Essar Investment Ltd. (‘EIL’) was a company holding the Essar brand including the trademark, copyright, and logo since 1996. Immediately after the formation of the Trust, EIL contributed the brand ‘Essar’ to the assessee Trust without any consideration. Subsequently, the Trust entered into brand license agreements with operating Essar group entities, in terms of which license fees were earned by the Trust. In this context, several issues arose as dealt with in this Interconnect.

Is the contribution a capital receipt?

Although there is not much discussion by the Tribunal on this aspect, there is a reference in the order that the receipt of the brand by the Trust amounts to a capital receipt and is, therefore, not taxable. The Tribunal has impliedly relied on certain decisions and these are briefly described below:

(a) CIT vs. Softworks Computers Ltd. [TS-5853-HC-2012(BOMBAY)-O] (Para 7)

(b) CIT vs. Stads Ltd. [TS-5192-HC-2015(MADRAS)-O] (Para 11)

The decisions above are not directly on the point; the first and third judgments are in the context of write-back of loans acquired for acquiring capital assets, and the second judgment above is in the context of an amalgamation reserve being sought to be taxed and the High Court had rejected the contention of the revenue department. However, the concept of capital receipts being not taxable has been reiterated despite the ever-increasing width and deeming fictions of the term ‘income’.

Is the Trust liable to tax at all u/s 28(iv) of the Income-tax Act (“Act”)?

Section 28 is the charging section for business income, but it has certain deeming fictions wherein items of receipt which would have been capital receipts have been roped into chargeability. This includes compensation of various types under section 28(iv) and also includes “the value of any benefit or perquisite …… arising from business or exercise of profession”. In this context, one question before the Tribunal was whether the Trust was liable to tax under section 28(iv) in relation to the receipt by it of the brand from EIL.

Section 28(iv) refers to benefit or perquisite arising from business or profession; the Tribunal held that the contribution by EIL to the Trust was on the same date that the Trust commenced its operations and therefore, it cannot be considered that the receipt of the brands is a benefit arising from a business carried on by the assessee Trust.

At this juncture, it may be pertinent to note that the Finance Bill, 2022 seeks to introduce section 194R to the Act, which provides that any person responsible for providing any benefit or perquisite to any other resident person, such person shall withhold tax at the rate of 10% on the value of such benefit or perquisite. Therefore, while this judgment dealt with the issue of taxability in the hands of the recipient (i.e., the Trust), there could be an additional litigation risk under the withholding tax provisions on the transferor, while the transferor could still argue that tax was not required to be withheld in the first place based on this judgment.

Is the Trust liable to tax u/s 56(2)(x)?

The predecessor section was 56(2)(vii)(c), [the relevant section currently is 56(2)(x)]; the relevant provision is that if there is a receipt by an assessee of ‘property’ without consideration, then it is taxable in the hands of the recipient. There are certain exceptions to this, but most importantly, the receipt must be of ‘property’ as defined; this is the context in which the receipt of the brand without consideration by the Trust from AIL was being examined vis-à-vis the deeming fiction of section 56(2). In some interesting observations, the Tribunal analyzed the situation as follows:

– The definition of ‘property’ is restrictive in nature and refers exhaustively to assets that fall under the definition.

– The definition of ‘property’ covers immovable property, shares and securities, and a few other assets, including ‘any work of art’.

– The Essar brand was registered as ‘artistic work’ under the Copyright Act 1957 and that was the crux of the argument of the revenue; if the artistic work is any work of art, then (in the tax department’s view) it would be within the meaning of the term ‘property’ and therefore, exposed to Section 56(2).

– There is a distinction between ‘work of art’ and ‘brand’; the term ‘work of art’ means an object made by an artist of great skill i.e., something considered to have aesthetic value.

– The Madras High Court in the case of M.A. Chidambaram [TS-5993-HC-1997(MADRAS)-O] had observed that trophies and cups, won by, the assessee (this was in a wealth tax context) could not be considered as works of art and that ‘work of art’ contemplates element of human skill.

– Accordingly, the Essar logo, while an artistic work, is not “a work of art” and is, therefore, outside the definition of the term “property” and therefore, not covered by the deemed income concept under Section 56(2).

Is the Trust liable to tax u/s 56(1)?

Section 56(1) of the Act provides that any income which has not been taxable under any of the other sections shall be taxable as “income from other sources” u/s 56(1) of the Act. Section 56(2) (which includes deemed income tax on receipts of certain properties, as elaborated above) is a more specific section that operates without prejudice to the generality of section 56(1). Therefore, the question before the Tribunal was whether the receipt of the said brand could be taxable under the general provisions u/s 56(1) as “income from other sources”. The Tribunal held that if the receipt of property does not fall within the definition of “income”, given that the same is a “capital receipt”, it should not be subject to tax as other income u/s 56(1) read with the definition of “income” u/s 2(24) of the Act.

Some other aspects

One of the interesting aspects is there was a gift by a company. There was no reason for the Tribunal to get into whether a company can make a gift and the ITAT did not get into that, but it is important to recognize that it does seem possible for a company to give a gift and there is nothing in law to prevent that. Incidentally, Section 45 of the erstwhile Gift Tax 1958 contemplated exemption for gifts by widely held companies, which implies that a company can make a gift in the first place. There are several examples, some of them linked to schemes of arrangement where corporate gifts have been made; a couple of examples are as follows:

– In Vodafone Essar Ltd. case [TS-151-HC-2011(DEL)] , the Delhi High Court was dealing with a situation where the transferor company was transferring passive assets without consideration to its wholly-owned subsidiaries as a part of a Scheme of Arrangement, and the Delhi High Court rejected one of the considerations of the tax department and held that nil consideration i.e., effectively a gift is valid even though by a company.

– The Mumbai Tribunal in the case of DCIT v/s KDA Enterprises (P) Ltd, [TS-310-ITAT-2015(Mum)] dealing with a situation where the assessee company received some amount as gifts from 4 companies, and the tax department contended that the amount was taxable (pre widening of the scope of Section 56 and it was held not to be so); the point to note is that the concept of corporate gifts has been accepted in this case.

With the introduction of section 56(2)(x) of the Act, one would need to be cognizant of the fact that certain “gifts” or transfers without consideration, while not taxable as capital gains in the hands of the transferor, may be taxable in the hands of the transferee, if the receipt of “property” is within the narrow contours of the definition of “property”, as mentioned above.

Lastly, while the aspect of “deemed dividend” u/s 2(22)(a) was not discussed under this judgment (presumably, since the Essar Brand would not have been recorded as an asset in the books of EIL), one would need to be cognizant of the deemed dividend implications on the distribution of assets, directly or indirectly, to the shareholders of the company involved.

Summing up

On the facts of the case, the Tribunal held that the receipt of the brand was a capital receipt, and therefore, was not taxable as income: a) as perquisite u/s 28(iv) of the Act; b) or as “income” under the general provisions of 56(1) of the Act; c) or as deemed gift u/s 56(2) of the Act because a brand does not fall within the definition of property.

This is an interesting decision by the Tribunal and in appropriate cases, the ability to delink the brand from a company for a variety of commercial reasons can be explored, and this decision will be helpful in this context.