[The following post is contributed by Vinod Kothari of Vinod Kothari & Co. The author can be contacted at firstname.lastname@example.org.]
When it comes the law imposing a requirement of spending on corporate social responsibility (CSR), which is 2% of the profits of the company, we come to notice all sorts of ingenious ways of companies trying to avoid or evade the requirement. Some might even go to the extent of treating personal events as spending on promoting art and culture, and therefore qualifies as a CSR spending. Some may want to book an expenditure on staff welfare as CSR. In essence, companies are trying to find smart ways of working around the requirement.
On the other extremity of corporate benevolence is a practice, whereby four private companies gifted, in all, Rs. 1618.6 million by way of a gift to a single donee company! The Income Tax Appellate Tribunal (ITAT), Mumbai, in a ruling of 11 March 2015 held that not only did the company have the power to accept gifts, such gifts being capital receipts in nature were not liable to be taxed.
If someone thought the donor companies must be extremely prosperous entities and might, therefore, be flush with generosity, the facts at least do not suggest so, since all the four companies actually gifted all of their dividend income from a particular investment to the donee. Also, one must not think the donee company is a not-for-profit (NFP) company which usually does accept gifts or corpus contributions to carry out its philanthropic activities. In short, there is no philanthropy, suggestion of charity, or a social cause at all. Four donor companies, having significant investment in a particular company, give irrevocable instruction to the company whose shares they are holding, gifting all of their dividend income from the particular investment, to a particular donee.
The ITAT seems to have confined itself to a narrow technicality of the question involved in the case, maintaining a tunnel-vision to the question whether a company could accept a gift, and if it did, whether the gifts are of a capital nature. As far as the power to accept a gift, the power of a company to do anything which is otherwise legal is typically conferred by amending the charter documents of the company. In this case, the Memorandum of Association was amended to confer a power to accept gifts.
Having thus established the power to accept a gift, the ITAT went at length discussing technicalities, such as, whether a gift could be regarded as business income, “income from other sources”, etc., or whether the gift is purely a capital receipt. Since there was no finding as to business connection of the gifts, the ITAT finally determined that the gifts were not arising out of the business of the donee company, and therefore, were purely capital receipts, and were therefore, tax free. Neither did the gifts have to appear in the profit and loss account of the donee and therefore, they were not even liable to be included for determination of “book profits”.
Respectfully, judicial and quasi-judicial authorities ought not to be confined to technicalities but must take a larger, rational view of the facts. The fact that the so-called “gift” was highly unusual and illogical is quite apparent. In fact, since all dividends from a particular investment were “gifted”, there was a at least a pointer to the real beneficial ownership of the shares, whose income was “gifted”.
Companies are artificial persons. Companies come into existence only for business or non-business purpose as mentioned in their constitutional documents. Companies do not have an existence beyond the law; therefore, they are a fiction created by law. They are instrumentalities for carrying out certain operations. Natural persons have a life much beyond their business or employment – they have relations, sentiments, bondages, and so on. Therefore, there is a case for natural love and affection due to which dealings such as gifts, settlements, inheritance etc take place in case of natural persons.
A company, on the other hand, is an artifice. It has no brain of its own except those who are behind the company. And it does not have any heart. Evaluating the artificial persona of the company, it might have seemed a no-brainer to say that whatever goodwill, liking or attachment the company has been able to create, which tempts someone to give a gift to the company, might have obviously been in course of business of the company. The company could not, in any case, have an existence outside its business. Presumably, no company could be doing anything which is not a part of its charter documents, or things in furtherance of its charter documents. Since what is in the charter of the company is its business existence, it is difficult to envisage how a capital receipt could arise not in course of business of the company.
It is quite common for NFP companies to obtain gifts, as that is the very nature of the company. Sometimes, start-ups also receive gifts. However, in the present case, it is income out of a certain investment which is gifted by shareholders of one company to another.
It is highly likely that the Income Tax Department will take the matter further in appeal. However, if the ITAT ruling becomes the last word on the subject, it will usher in a series of similar transactions. The transaction, from the perspective of a tax planning, makes tremendous sense. Since dividends are tax free, the dividends gifted away cannot be taxed in the hands of the donor company on the principle of sec 60 of the Income-tax Act (transfer of income without transfer of the underlying assets). There is no case for bringing the dividends in the profit and loss account of the donor company, as the company has ceased to have beneficial interest in the dividends, having gifted them away. As regards the donee company, the dividend stream will escape the profit and loss account, as it is a capital receipt, and therefore, will escape book profits tax. Effectively, the device of one holding company gifting its dividend stream to another company may become an easy way to escape book profits tax on inter-corporate dividends.
- Vinod Kothari