Corporate Benevolence: Companies May Accept Gifts, and Tax Free

[The
following post is contributed by Vinod
Kothari
of Vinod Kothari & Co. The author can be contacted at
[email protected]]
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

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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