Business Succession
Legal Overview & Fundamental Concept
Every person who is born is destined to die. Whatever money or material he accumulates in his lifetime is left for his nears and dears, after his death. This type of transfer of his ownership rights is called Succession. It is different thing that during his life, he assigns the rights to someone through a “Will” Otherwise the property will be distributed by court among heirs as per the rules of his religion. If a man has established a business with his own funds or in association of other persons’ fund, or has associated with a Corporate Entity, which is an artificial person, as a shareholder, he has still the right of succession of his business. In this article, we will discuss about the rules of succession of each type of business, and how the successors can possess the rights of running the business and transfer of ownership, without any hassle and fear of payment of tax / stamp duty, as is the law governing the transfer of property of an individual.
1. What is Succession
The word succession is a word of technical meaning. It refers to act of vesting of rights of ownership of properties of a person in the name of his heirs and successors, after his death. “Person” herein above include an individual, and other juristic person namely business entities including of course, firms, partnership, companies, incorporated or not. The “vesting” is synonymous of word “transferring,” but these have different interpretations in different contexts and laws. Broadly, vesting means the passing the right of ownership, by mutation of the name of successor in the official BOOKS of the Govt. records and registers.
Successor is an apt word for those to whom the property is vested, being the heirs or administrators, or any other beneficiaries. The successors exclude those who by any deed, grant, gift, or any other mode of purchase or contract, get the property of the deceased, during the life time of the person.
Key Principles Governing Property Vesting and Business Effects:
- Inheritance and Accumulation: A person possesses a property inherited by his father or forefathers, and later he keeps on adding more properties by utilisation of savings out of his income. The properties may be immovable like land and building, and movables like deposits, shares, units of mutual funds, LIC policies, and other schemes, so that he is able to face and avoid the hardships of his life and also his family after his death. Some enterprising person invest in business, or setting of own profession, so that he protects the life of those heirs also, who have diverse interests in life. His investment in business is in the form of premises, plant and machinery, capital assets, raw material, and keeping money in banks for working capital etc. These are called the business properties.
- Scope of Property & Inseparable Liabilities: Property is a wide enough to include other personal and business effects, intangible assets like goodwill, licenses, permits, franchise rights, royalties etc. Some of the properties of individual and of business also have some pending liabilities. In case of succession of individual, the net value of assets gets transmitted officially, whereas in business, net worth of all assets move along with all liabilities, in one bag, to the successor. In a running business, the assets and liabilities are inseparable.
- Succession vs. Inter-Vivos Transfer: The succession process has different process and advantages over the process of transfer of properties and goods, from the view of passing consideration and giving delivery to other. In the case of individual’s succession, the transfer is executed after death, whereas, the transfer of property by the individual is, by real delivery or contract, or mortgage, during his own life time, which is sheer transfer.
2. Individual’s Succession Under Hindu Succession Act, 1956
It is necessary to view the process of succession of individual before jumping to our interesting topic of “Business Succession”. The succession of individual person takes place as per the law governing his religion and traditions. Hindu succession Act which applies on Hindus, Sikhs, Jains, and Buddhas, is different from Muslim law and Parsi law.
Here below, we concentrate on Hindu Succession Act 1956 only. According to this law, there are two ways of Succession viz.:
1. Testamentary Succession
In the first process, a wise person, by virtue of knowledge and practical wisdom, writes his Last Will, with his sound mind and without any pressure or influence wherein, he proposes to distribute his assets, legitimately acquired or earned, to his heirs and others, (which not his relatives, necessarily) in such proportions, as rightly justified. He writes his Letter of Mandate, so that on the question of distribution of assets on his death, there is no dispute or litigation. This mandate is witnessed by two persons, and for execution of mandate, the Executor is appointed also. It is not mandatory, though desirable to get that registered under Indian Registration Act. This mandate can be modified to add or delete any part, or revised fully as and when circumstances warranted.
2. Succession by Law Courts
If the individual has not written any will or has left some assets, in the Will, or he meets his death, before awareness of the advantages, the succession of his properties is done thru Court procedures and final issue of order of Heirship / survivorship. Who constitute heirs? This is provided in the Act. In old days, only the male heirs were counted but as per Act of 1956, male and female children, spouse and parents have been entitled to their share in distribution of assets. Naturally and normally, after marriage, every person leaves behind, more than two heirs. Therefore, every asset has to be divided and partitioned in many parts, unless and until all, reach a family compromise, or agree to sell and distribute the net value, in proportion to the individual’s entitlement or agree to keep the assets under common custody till the heir finally agree to sell on any later time. Notwithstanding anything, the business of the individual is succeeded in the manner as enumerated in the following discussion of Business Succession.
3. Basic Differences and the Stamp Duty Debate (Hindustan Lever Ruling)
On the subject of business succession, there are two schools of thoughts:
One who agree with the opinion held by Supreme Court, in its order on amalgamation, in the matter of Hindustan Lever in 2004. According to this, Amalgamation, sanctioned by the court would be a transfer inter-vivos and would be different from succession or device and so shall be subject to levy of stamp duty on the value of assets.
The second school opined that in amalgamation of business, the whole running business gets transferred, lock, stock and barrel, therefore, it needs to be looked as one asset. Transfer of asset in business, is by operation of law, and it does not fall in the definition of conveyance. So stamp duty is not chargeable. They further opine that business of natural persons and artificial persons (Corporate) have like entitlement of Succession, and none of these should be treated differently, despite the fact that characters of business are different from the individual. The asset value of a running business and value of liabilities cannot be separated unit-wise so, it is not exactly determinable value, hence imposition of stamp duty, on asset, category-wise is impossible. Therefore, neither logically nor practically, it is a useful exercise.
Distinctive Differences: Individual Succession vs. Business Succession
| No. | Individual’s Succession | Business Succession |
|---|---|---|
| 1 | There can be succession of individual without there being the succession of his business. | Business succession involves the entire operating entity and cannot be detached from commercial continuity. |
| 2 | Operates via two modes: Testamentary (Will/Mandate) or Court proceedings (Heirship/Survivorship). | Succession of business is executed through law courts (Civil or High Court / NCLT) sanctioning the scheme. |
| 3 | Distribution of assets of the deceased person takes place strictly only after actual death. | Starts even while business is alive and ongoing, pursuant to partnership deeds, MOA/AOA, and relevant statutes. |
| 4 | Transfer of assets goes into hands of successors after an inevitable gap of time. | Practically no time gap, as management and assets move simultaneously in seamless commercial continuity. |
| 5 | Enriches the successor’s property, but sometimes weakens family ties due to partition disputes. | Strengthens family ties and brings collective prosperity to everyone when the business grows and enlarges. |
4. Business and Income Tax Implications (Sections 56 & 47)
All business fall under the ambit of Income Tax act. All profits and gains arising out of that business become liable to tax (subject to exemptions, applicable on various types of business or even single man’s business. It has already been explained that no income is generated unless some goods and services are transferred or exchanged between the two. Transfer is therefore, cradle on which business moves and money is received. Thus, profits are derived by calculating difference of receipts/income and expenditure. There are some transactions, which are exempted from the computation of income, and thus raising profits of business. Similarly, there are certain transactions of transfer of capital assets, from which the business gets extra income and then increases the tax liabilities. In some cases of transfer of capital assets, the gains of receipt over cost, are taxable under heading of capital gain tax.
Section 56(1) and Section 47 Tax Exemptions:
Provisions of Section 56 (1) list out the receipts, exempted from computation of Tax liability of individual/ business: - The receipts from relatives, on the occasion of marriage, or other ceremonies, or by way of inheritance / succession, among other reasons. The relatives include spouse, children, parents, brothers and sisters, which fall in the category of lineal ascendants or descendants, as per Hindu Succession Act.
Therefore, a Hindu person becomes happier when he gets any money or fund by way of inheritance / successor, vis-à-vis getting money transferred through any other source. Similarly, an individual gets exemption from payment of capital gain tax, if capital is transferred to him from his predecessors in the nature of inheritance. (For details, refer section 56 and section 47 of Income Tax Act.)
5. Succession in Sole Proprietorships & Corporate Conversion
It is a business where an individual is the owner of all immovable assets, capital assets, working capital, skill and intangible assets, owned by him in his name or in the name of the firm, given by him. He is equally liable to clear all obligation relating to that business. On his death, there is an option of closing the business by sale and to distribute the consideration received. If this option is not agreed, then alternative is to start process of Succession.
After the death of the owner of the proprietorship firm, if there is no concurrence of all heirs, to appoint only one to succeed as successor, then other option is to keep the business in joint ownership, each one to be reckoned as a partner. Further, understanding that in practice and reality in view, that for long there cannot survive friendly and amicable relations, for one reason or other, the heirs may consider converting proprietorship in to a public limited or private limited company., keeping their vigil that they get all possible exemptions from the income / capital gain tax computations.
Statutory Conditions for Tax-Free Conversion [Section 47(xiv) & Section 47A]:
- All the assets and liabilities of proprietorship firm become the assets and liabilities of the company.
- All the heirs become shareholders of the company, keeping fixed their share capital, as existed in the firm.
- The aggregate shareholding of the heirs, becoming part of company, is not less than 50 percent of total capital.
- The heirs do not get any benefit other than the shares allotted to them in place of their part of capital. (Read section 47(xiv) and section 47A of the Act - for details).
6. Succession in Partnership Firms & Amalgamation Provisions
It is a form of business establishment incorporated under Indian Partnership Act 1932. It is a voluntary contract between Two to Twenty competent persons, to place their monies, personal effects, labour, skills, some or all of them, in a lawful commerce / business activity, with the understanding that there shall be a communion of profits and loss, in certain proportion. All the terms and conditions are mentioned in Partnership deed and business has to run in prescribed manner, in the name of firm and not in the name of any partner. Their obligations are all joint and indivisible.
The purpose of succession of Partnership business is to give useful engagement to all the heirs of all the partners, and to ensure that profit share of every family grows over the time. Therefore, while planning for growth of business growth, there is need of expanding the size, territory, and capital base. The succession of partnership be planned in such a manner that if any of the families want to quit, then they conveniently do so , without breaking or killing the continuity of business .
The number of partners cannot exceed 20, so the partners should consider converting to Private or Public Ltd. Company. Which gives growth. While vesting the business in other running business, or changing to company, opportunity to avail exemptions under relevant provisions of section 47 and 56 , should be prime considerations:
Partnership Conversion & Amalgamation Requirements:
- All partners become shareholders of company.
- Partners do not receive any other money in consideration.
- The aggregate of capital of partners in company should be not less than 50 percent of total voting power.
- Provisions of section 47A should be kept in mind also.
- Partnership firm can convert itself in Company or alternatively can amalgamated in to another existing company. Therefore, procedures of Amalgamation will have to be followed strictly. Partnership firm would be taken as an unregistered company u/s 582(b) of the Companies Act.
7. Succession in Companies: Merger & Amalgamation Framework
Company means a company incorporated under the provisions of Indian Company Act., as a private limited or a public limited company, or in any other manner. A private can extend its shareholders between 2 to 50. On the other hand, a public limited company can extend shareholders no. from 7 to unlimited number.
To achieve the advantages of consolidation of two or more companies of the same parent company, or. holding company and subsidiary company, so that stake holders of both companies get advantages of economies of scale, Savings of functional and administration expenses, and pushing the company for better marketing and brand image, may agree with each other, prepare a scheme of merger of companies and proceed for amalgamation of companies pursuant to rules made in section 391-395 of Companies Act, and relevant provisions of income tax and capital gain tax.
Exemption Conditions Under Section 47(iv) Inter-Alia:
- Any transfer of capital asset by a company to its subsidiary company, and if the parent company holds the whole of the share capital of subsidiary company.
- Any transfer of capital asset by a subsidiary company to a holding company, if the capital of subsidiary company is held by the holding company.
- Any transfer, in a scheme of amalgamation, of a capital asset by the amalgamating company to the amalgamated company.
- Any transfer of shares of the amalgamating company with the shares of amalgamated company, and company is an Indian company.
The crux of the whole issue is that entities need to follow all the procedures and compliances, as per section 391-394 of companies act 1956 or relevant provisions under new amended Act of 2013.
Definition of Amalgamation Under Income Tax Act [Section 2(1B)]:
Amalgamation in relation to companies means that they merged in such a manner that:
- All the property of amalgamating company become the property of the amalgamated company;
- All the liabilities also become liabilities of the amalgamated company;
- Shareholders holding not less than three fourth in value, other than shares held in new company before they become shareholders of the amalgamated company.
This implies that if there is complete compliance of section 391-394 of the companies act as well, procedure is satisfying the conditions of section 2(1B) of Income Tax, then it implies that amalgamation of companies is deemed as succession of two companies.
8. Conclusion: ITAT Pune Precedent (Capgemini Case) & Total Succession
ITAT Pune Landmark Ruling: Cap Gemini Tech v/s ACIT (Appeal No. 1857/PUN/2017 - August 2022)
This final conclusion and view has been fully supported by a recent judgement of ITAT (Pune) in appeal no 1857: Pune / 2017, in the case of Cap Gemini Tech v/s ACIT, issued in August 2022. It clarified that scheme of amalgamation approved by High Court is a binding order on all, to consider that the transferee company / amalgamated company enjoys all benefits to which the amalgamating was entitled before amalgamation.
In other words, successor company is full representation of the predecessor company as far as the ownership of all assets and obligations of liabilities and also all rights, benefits and privileges.
This makes us to infer that orders of High court and order issued by Registrar of Companies, deleting the name of amalgamating company (without formal winding) and joining the file of the amalgamating company with in the file of amalgamated company is sufficient process of Succession of one company to other. Thus the transfer of one company/business, after its exit, into other, is not a case of Transfer, it is 100 percent case of Succession of company/business of a company.
If the decision of ITAT continues to hold water, and is accepted by all authorities dealing with matters of Transfer of Properties, then on transaction of business succession by virtue of Sanction of Scheme of Amalgamation, will not attract the stamp duty or other taxes. The successor company will stand strongly in the shoes of the predecessor company. Hundreds of business entities who have not got immunity so far from the burden of levy of tax on their mind will get relief.