Section 47 of Income Tax Act

Section 47 iii of the Income Tax Act is a key provision that exempts specific transactions from being classified as ‘transfers’, which helps in avoiding capital gains tax. According to the Income Tax Act, any profit or gain arising from the transfer of capital assets is generally subject to capital gains. However, Section 47 outlines a variety of transactions that do not fall under the category of transfers, thereby ensuring that these transactions do not incur capital gains tax.

For example, transactions such as the distribution of assets during the partition of a Hindu Undivided Family (HUF), the transfer of assets during amalgamation or merger of companies and certain transfers to the government or charitable trusts are some of the few transactions that are considered under the list of transactions not regarded as transfers as per Section 47 under the Income Tax 1961. These exemptions help reduce the tax burden on taxpayers.

By defining these exclusions, Section 47 allows smoother financial transitions, such as business restructuring or asset distribution, without triggering tax liabilities. This promotes financial efficiency and tax planning.

-Transfer of Capital Assets Under a Gift or Will

One of the primary provisions under Section 47 is the exclusion of capital asset transfers made through a gift, will or irrevocable trust from being classified as transfers. This means that when an individual transfers an asset as a gift or inherits it through a will, no capital gains tax is applicable.

-For Example

If a father gifts his house to his son, the transfer of ownership does not attract capital gains tax. Since the transaction falls under the exemption for gifts, it is not considered a taxable transfer.

-Transfer Between Holding and Subsidiary Companies

• Transfers of assets between a holding company and its wholly-owned subsidiary, or even vice versa are not regarded as transfers. This is the case provided that the subsidiary company is a company of Indian origin.

• This provision facilitates the smooth transfer of assets within a corporate group without incurring additional tax burdens.

-For Example

Let us consider that a holding company named Asha Ltd. transfers some of its machinery to its 100% Indian subsidiary named Usha Ltd. Since the subsidiary is an Indian company, this transaction will not be considered a transfer and no capital gains tax will be imposed.

-Transfer in a Scheme of Amalgamation

• When an amalgamation occurs, where one company merges with another, the transfer of capital assets to the amalgamated company is not considered a transfer under Section 47 of the Income Tax Act.

• However, this is the case only if the amalgamated company is a company of Indian origin. This encourages corporate restructuring and mergers without causing unnecessary tax liabilities.

-For Example

Suppose Mamta Ltd. merges with Lata Ltd. and Lata Ltd. is an Indian company, the assets transferred to Lata Ltd. as a part of the merger will not be regarded as a transfer. This will help the companies avoid capital gains tax.

-Transfer in a Scheme of Demerger

Similar to amalgamations, transfers of capital assets during a demerger, that is, when one company splits into multiple companies, are not considered transfers if the resulting company is not of Indian origin. This provision aims to simplify business reorganisation by preventing capital gains tax from being imposed in these cases.

-For Example

Let us consider an Indian company named Wellness Ltd. that runs an Ayurvedic soap business. This company demerges its cosmetic division to a new company named Beauty Ltd., which is also of Indian origin. The transfer of assets from Wellness Ltd. to Beauty Ltd. will not attract capital gains tax as it is covered under Section 47 of the Income Tax Act.

-Transfer of Capital Assets by a Shareholder in Case of a Demerger

• Section 47 of the Income Tax Act also exempts shareholders of a demerged company from paying capital gains tax when they transfer shares of the demerged company to the resulting company.

• The resulting company must be an Indian Company to qualify for this exemption. This provision of exempt transfer under section 47 prevents shareholders from facing capital gains tax liabilities during company reorganisation.

-For Example

In the case of the demerger of Wellness Ltd. mentioned in the previous example, if a shareholder of Wellness Ltd. enhances their shares for shares of Beauty Ltd., they will not incur any capital gains tax on this transaction.

-Transfer in a Scheme of Business Reorganisation

In cases where a cooperative bank is merged into a banking company as a part of a business reorganisation scheme, the transfer of assets is not considered a taxable transfer. This exemption applies specifically to reorganisations involving a predecessor cooperative bank and a banking company.

-For Example

If a cooperative bank merges its assets with a private Indian bank as a part of a reorganisation scheme, the transfer of the cooperative bank’s capital assets to the banking company will not trigger capital gains.

-Transfer in the Case of Conversion of Proprietorship into Company

• When a sole proprietorship is converted into a company, Section 47 of the Income Tax Act excludes this transaction from being considered a transfer. However, this is the case provided that the following conditions are met:

• All assets and liabilities of the proprietorship are transferred to the company.

• The resulting company is of Indian origin.

• The sole proprietor becomes a shareholder in the new company.

• The proprietor retains at least 50 % of the shareholding for five years from the date of conversion.

• This provision ensures a smooth transition for entrepreneurs converting their sole proprietorships into companies without facing tax implications.

-For Example

• Suppose Deepa is the owner of a sole proprietorship. She decides to convert her business into a private limited company and hence, transfers all the assets and liabilities to the new company.

• Since the new company is of Indian origin and Deepa becomes a shareholder, this transaction will not be treated as a transfer under Section 47 of the Income Tax Act.

-Transfer in the Case of Conversion of a Partnership Firm into a Company

Similar to sole proprietorship, the conversion of a partnership firm into a company is not considered a transfer if the following conditions are satisfied:

• All assets and liabilities of the partnership are transferred to the new company.

• All partners become shareholders of the new company in the same proportion as their capital in the firm.

• The total voting power of the partners or shareholders must remain at 50% or more for five years from the date of conversion.

• This helps facilitate the conversion of partnership firms into corporate entities without triggering capital gains tax.

-For Example

Suppose Patel Partners, a partnership firm, is converted to Patel Pvt. Ltd., with all partners becoming shareholders in the company. Since the partnership’s assets and liabilities are fully transferred and the partners maintain at least 50% of the voting power, the conversion will not attract capital gains tax.

-Transfer in Certain Other Cases

• Section 47 of the Income Tax Act also covers other specific scenarios where transactions are not regarded as transfers, such as:

• Transfers of assets under the Securities Lending Scheme:

• Under the Securities Lending Scheme, when securities such as shares or bonds are temporarily transferred from one party to another, capital gains tax is not applicable.

• Transfer of membership rights in a cooperative society:

• When a person transfers their membership rights in a cooperative society, it is not regarded as a transfer under Section 47 of the Income Tax Act.

• Transfers of assets to the government or local authorities:

• Any transfer of capital assets to the government or local authorities is exempt from capital gains tax under Section 47 of the Income Tax Act.

• These additional provisions ensure that certain specialised transactions remain outside the purview of capital gains tax.

-For Example

• Let us assume that Ms Kalki lends her shares of Ashoka Ltd. to a broker under a securities lending agreement for a specific period. Since this transaction is a part of the Securities Lending Scheme, it is not considered a transfer for tax purposes. Hence, Ms Kalki does not need to pay capital gains tax on the temporary transfer.

• Suppose Ms Ria holds membership in a housing cooperative society. She decides to transfer her membership rights to Mrs Rao. This transfer of membership rights will not attract capital gains tax since it falls under the exemptions provided by Section 47 of the Income Tax Act.

Let us assume that a company named Lotus Ltd. transfers a piece of land to the local municipal authority for the development of a public park. Since the transfer is made to a local authority, it is not regarded as a transfer and no capital gains tax is payable by Lotus Ltd.

Section 47 of the Income Tax Act provides exemptions from capital gains tax for specific transactions, but these exemptions are only available if certain conditions are strictly met. Taxpayers and corporate entities must ensure compliance with these conditions to benefit from the exemptions.

For example, in the case of a transfer between a holding and a subsidiary company, both entities must be of Indian origin. Similarly, in an amalgamation, the resulting or combined company must be an Indian entity.

Another key requirement is that during the conversion of a firm or partnership into a company, all assets and liabilities of the firm must be transferred and the shareholding pattern must remain unchanged.

Failure to meet these conditions can lead to the transaction being treated as a taxable transfer and can be subjected to capital gains tax. Therefore, strict adherence to the rules under Section 47 of the Income Tax Act is necessary to ensure that such transactions remain exempt from capital gains tax, avoiding any unintended tax liabilities.

-Implications for Individual Taxpayers

**-Estate Planning **

Section 47 of the Income Tax Act is a valuable tool for individual taxpayers involved in estate planning. By exempting gifts and wills from capital gains tax, it allows individuals to transfer assets within their family without incurring tax liabilities.

This can be particularly beneficial for individuals with substantial wealth who want to ensure a smooth transition of their assets to future generations.

**-Succession Planning **

The provision facilities succession planning by enabling individuals to pass on assets to their heirs in a tax-efficient manner. This can be especially important in family-owned businesses, where the transfer of ownership can be a complex process. Section 47 of the Income Tax Act can help ensure a seamless transition of ownership and prevent disruptions to the business operations.

**-Wealth Preservation **

Section 47 of the Income Tax Act helps individuals preserve their wealth by minimising capital gains tax on asset transfers. This can be particularly useful for individuals who want to avoid eroding their wealth through unnecessary tax liabilities.

By reducing the tax burden on asset transfers, Section 47 of the Income Tax Act allows individuals to retain more of their wealth for themselves and their families.

**-Retirement Planning **

For individuals planning for retirement, Section 47 of the Income Tax Act can be a valuable tool. By allowing individuals to transfer assets to their heirs without incurring capital gains tax, Section 47 of the Income Tax Act can help individuals build a safety net for retirement that is more secure and resilient against market fluctuations and inflation.

-Implications for Corporate Taxpayers

**-Business Restructuring **

Section 47 of the Income Tax Act is instrumental in corporate resturing. By exempting certain internal transfers from capital gains tax, it allows companies to reorganise their business operations more efficiently and strategically. This can include activities such as mergers, acquisitions, demergers and spin-offs.

**-Mergers and Acquisitions **

The provision to exempt transfer under Section 47 can be beneficial in mergers and acquisitions, reducing the tax burden associated with transferring assets between entities. This can make these transactions more attractive to both acquiring and target companies.

**-International Asset Transfers **

Section 47 facilitates the seamless transfer of assets within a corporate group without incurring capital gains tax, promoting operational flexibility. This can be particularly useful for companies with complex corporate structures or those that need to reorganise their assets to improve efficiency or profitability.

**-International Tax Planning **

Section 47 can also be useful for companies engaged in international operations. By exempting certain cross-border transfers from capital gains tax, Section 47 can help companies reduce their overall tax burden.

Section 47 of the Income Tax Act offers significant tax relief by excluding certain transactions from capital gains tax. This is crucial for individuals and corporations alike, aiding estate planning, succession, wealth preservation, business restructuring and international tax planning.

Understanding the nuances of Section 47 iii of the Income Tax Act is vital for taxpayers seeking to minimise tax burden and optimise financial outcomes in the future.

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