A family settlement is not a species of transfer like partition nor it is a commercial contract. Family settlement have received judicial recognition and are enforceable in the Court of law.
A family arrangement is an arrangement between members of the same family intended to be generally and reasonably for the benefit of the family by avoiding litigation or to maintain its reputation. It may involve even settlement of bona fide disputes ether present or future which may not involve legal claims. So, firstly, it must be an agreement among the members of Hindu Family to settle some matters of dispute or otherwise. Secondly, the object must be to compromise either doubtful claims or disputed claims or to preserve the peace in the family or to maintain its reputation by avoiding litigation. Thirdly, the agreement has consideration of expectation that such agreement or settlement will result in establishing or ensuring amity or goodwill amongst the members of the family.
Briefly, the ingredients of a family arrangement can be summarized as follows:
(i) Arrangement is based on assumption that there is an antecedent in the parties to the arrangement.
(ii) The agreement acknowledged what that title is.
(iii) Each party relinquished some claims in favour of others.
(iv) There is a recognition by some of the rights in favour of others.
(v) The object is to avoid and settle disputes.
(vi) The dispute may be existing or likely to arise in future.
(vii) The arrangement should be bona fide and the terms reasonable.
(viii) If there is no dispute, present or future there can be no family arrangement. Thus, a family arrangement when it is bona fide entered into and for the benefit of the family will be generally enforced by the Court of Law.
a) Potti Lakshmi Perumallu v. Potti Krishna Venamma AIR 1965 SC 825
and in such cases the rule of evidence such as estoppel election etc. will be applied.
b) P. G. Hariharan v. Padarul AIR 1994 Ker. 36
c) P. N. Wan Kudre v. C. S. Wankude AIR 2001 Bom 129
A family arrangement generally would not require registration, but if the titled vested in one person is transferred to another in an immoveable property it would require registration.
d) Shambhu Prashad Singh v. Phool Kumari AIR 1971 SC 337
e) Digamber Patil v. Devram Girdhar Patil AIR 1995 SC 1728
Where the family settlement was made orally and subsequently a Memorandum of Family Settlement was signed recording settlement it was held that it did not require registration. The word “Family” is to be understood in a broad sense and parties to family arrangement may not necessarily belong to the same family. If the dispute is one between near relations then the settlement of such dispute can be treated as “Family Arrangement”.
Krishna Biharilal v. Gulabchand AIR 1971 SC 1041
1. Taxation Implication
It will not attract any income-tax as the arrangement is among the members of the family.
Section 56(2) of Income-tax is applicable for transfer of assets between persons with inadequate consideration or without consideration. However, the said section 56(2) does not apply to “Family Arrangement”.
Hon’ble Supreme Court in Ramcharandas v. Girjanan Devi AIR 1966 323 held as under:
(i) To put an end to dispute amongst the members of the family is not a transfer. It is also not a creation of interest.
(ii) In family settlement each party takes a share in the property by virtue of an independent title which is in fact admitted by other parties.
(iii) Each Party need not have a legal claim to be share in the property.
(iv) It is necessary to show that the parties are related to each other in some way and a possible claim on property or possible claim on some other ground.
(v) Apex Court in Kale v. Dy. Director of Consolidation AIR 1976 SC 807
It laid down two important aspects of family arrangement, they are:
It must be bona fide one to resolve the family dispute and rival claims by fair and equitable division or allotment of properties amongst various members of the family. Settlement must be fair and voluntary free of coercion or fraud.
2. Halsbury’s Laws of England:
It defines family arrangement as under:
“A family arrangement is an agreement between the members of the same family, intended to be generally and reasonably for the benefit of the family, either by compromising doubtful or disputed rights or by preserving the family property or the peace and security of the family by avoiding litigation or by saving its honour.”
3. To constitute a valid family arrangement:
(i) The transaction should be one which is for the benefit of the family generally.
(ii) The consideration for arrangement may be the preservation of family, property, preservation of peace and honour of the family or the avoidance of litigation.
(iii) It is not essential that there should be a doubtful claim, or disputed right to be compromised. If there is one, the settlement may be upheld if it is founded on a reciprocal give and take and there is a mutuality between the parties, in the one surrendering his right and in the other forbearing to sue. In such cases, the Court will not too nicely scrutinize the adequacy of the consideration moving from one party to the other.
(iv) In any case, if such an arrangement has been acted upon, the courts will give effect to it on the ground of estoppel or limitation and the like.
(v) A family arrangement may also be upheld if the consideration moves form a third party.
(vi) If it appears to the Court that if one party has taken undue advantage of the helpness of the other and there is no sacrifice of any right or interest, the agreement is unilateral and devoid of consideration.
(vii) The consent of the parties should be freely given to the arrangement end gross inadequacy of consideration may be determining factor in judging whether the consent was freely given.
(viii) If the agreement involves or implies injury to the person or property of one of the parties, the courts retain inherent power to prevent injustice being done.
Surendra Sahu Gountia v. Chamra Sahu Gountia  Cut. 591 AIR 1954 (Orissa) 80
4. Binding effect and the essentials of a Family Settlement:
The Supreme Court in Kale v. Dy. Director of Consolidation  3 SCC 119;
has laid down the following propositions in the matter of binding effect and essentials of a Family Settlement.
(i) the family settlement must be bona fide one so as to resolve family disputes and rival claims by a fair and equitable division or allotment of properties between various members of the family.
(ii) the said settlement must be voluntary and should not be induced by fraud, coercion or undue influence.
(iii) the family arrangement may be even oral in which case no registration is
(iv) It is well settled that registration would be necessary only if the terms of the family arrangement is reduced in writing. Hence, also a distinction be made between a document containing the terms and recitals of family arrangement made under the document and a mere Memorandum prepared after the family arrangement had already been made either for the purpose of the record or for the information of the Court for making necessary mutation. In such a case, the memorandum itself does not create or extinguish any rights in immoveable properties and, therefore, does not fall within the mischief of Section 17(1)(b) of the Registration Act, 1908 and is, therefore, not compulsorily registerable.
(v) The members who may be parties to the family arrangement must have some antecedents, title, claim or interest or even a possible claim in the property which is acknowledged by the parties to the settlement. Even if one of the parties to the settlement has no title but under the arrangement, the other party relinquishes all its claim or titles in favour of such a person and acknowledges him to be the sale owner, then the antecedent title must be assumed and the family arrangement will be upheld and the Courts will find no difficulty in giving assent to the same.
(vi) Even bona fide disputes, present or possible, which may not involve legal claims are settled by a bona fide family arrangement which is fair and equitable, the family arrangement is final.
5. No transfer in case of family arrangement:
It is well settled that there is no transfer in case of family arrangement. Consequently, where there is a rearrangement of shareholding as between family members to avoid possible litigation and to ensure effective control of different companies, there is no transfer within the meaning of section 2(47) of the Income-tax Act, so as to attract capital gains. Kay Arr Enterprises v. Jt. Commissioner of Income-tax 279 ITR (AT) 163 (Chennai); CIT v. R. Ponnmmal, Madras  164 ITR 706 (Mad.).
Though a company in which family members are interested may not be a party to the family arrangement.
6. Family Arrangement and decided cases:
(i) The transaction of a family settlement entered into by the parties bona fide for the purpose of putting an end to the dispute among family members does not amount to transfer . CTI v. R. Ponnammal 164 ITR 706 (Mad.).
(ii) Where a person owning site puts up a structure thereon and effects a partition between himself, wife and son by way of family arrangement on the ground that his wife and son had loaned amounts for construction of the property. No, it is not a family arrangement unless it could be shown that the wife and son had claimed that they had contributed was for interest in the property and net loan or gift giving rise to a dispute as between them, family arrangement cannot be valid. Banarasi Lal Aggarwalv. CGT 230 ITR 114 (P & H)
(iii) If a person who can act on his behalf as a guardian either under personal law applicable to minor or signed by person appointed by the Court on his behalf, the family arrangement could be valid. But where the arrangement is between father and minor son and is colourable and therefore, not genuine, it may not be treated as family arrangement. K. Venugopal v. CIT 248 ITR 251 (Mad.).
(iv) A Court may decree specific performance to give effect to family arrangement, if such arrangement has been made in good faith to resolve bona fide disputes, present or possible legal effect may be given to such arrangement by a court degree. Family arrangement is legally enforceable. Gulam Abas v. Haz Air 1973 SC 554.
(v) A mistake as regards rights of the parties, on the basis of which compromise is made in a family arrangement, the validity of the same is not lost. Cashim v. Carlo AIR 1938 PC 103.
The same principle was followed to uphold the validity of a family arrangement in a gift tax case CGT v. Pappathi Anni 127 ITR 655 (Mad.).
(vi) Family arrangement is a settlement which does not involve any transfer. It cannot, therefore, give rise to liability for capital gains. This law was repeated in CIT v. R. Nagaraja Rao 352 ITR 565 (Karn.). They followed the decision in Ziauddin Ahmed v. CIT 102 ITR 253 (gau). Refer. also CIT v. Ashwani Chopra 352 ITR 620 (P& H).
7. Other Important Cases on family arrangement.
i. Transfer of shares was for equalization of wealth of the family members which had monetary connotation, the same cannot be said to be voluntary (ACIT v. Bilakhia Holdings (P.) Ltd.)(Ahmedabad Trib.)
Family arrangement was to equalize the holdings between the respective families of three brothers. Therefore, it cannot be said that consideration for transfer of shares cannot be measured in terms of money or monies worth. The equalization of wealth has only monetary connotation. To avoid disputes cannot be said to be without monetary consideration as it is common knowledge that family disputes ruin the family financially. The family disputes are being settled in monetary terms by resorting to arbitration and in case such settlements is not done, matter travels to the court and the family suffers heavily not only mentally but also financially. There is a proverb according to which it is said that a person who wins a case actually looses it as by the time matter is settled in his favour he is already a ruined person. Thus, it cannot be said that the consideration for transfer of shares was not for monetary consideration.
Further the transfer was in pursuance of family arrangement, the same was not voluntary as the family arrangement was enforceable and binding on the parties. The argument made on behalf of the assessee that since the family arrangement was voluntary the subsequent action of the parties to the arrangement was also be considered voluntary. But it was held that the argument advanced by assessee devoid of any merit because if this argument of the assessee is accepted then what was the need of signing enforceable binding family agreement in the first place.
ii. Family arrangement among the assessees does not amount to any transfer and hence, not exigible to capital gains tax (CIT v. Kay Arr Enterprises)(Madras high Court).
There was a transfer of shares in the assessee-firm which consisted of partners, who were family members. in that, certain new shares were acquired in exchange of old shares, as also some consideration was paid in cash. According to the assessees, the transfer was consequent to a family arrangement. But the Assessing Officer, after analyzing the facts of the case and the legal aspects on the same, concluded that there was indeed a transfer involved and, thus, subjected the transaction to capital gains tax. The Tribunal held that the re-arrangement of share holdings in the company to avoid possible litigation among family members was a prudent arrangement necessary to control the company effectively by the major shareholders to produce better prospects and active supervision as otherwise there would be continuous friction and there would be no peace among the members of the family and held that such family arrangement could not be held as transfer which was exigible to capital gains tax.
The Madras High Court held that the law on the point involved is well settled by the decisions of the Apex Court in Maturi Pullaiah v. Maturi Narasimham AIR 1966 SC 1836, and in Kale v. Dy. Director of Consolidation AIR 1976 SC 807. In view of the settled proposition of law, the Tribunal was justified in arriving at the conclusion that the family arrangement among the assessees did not amount to any transfer and, hence, was not exigible to capital gains tax. Accordingly, no substantial question of law arose.
iii. Word ‘transfer’ does not include partition or family settlement (CIT v. R. Nagaraja Rao) ( Karnataka HC)
Family members of assessee were holding apart from personal properties, family properties and shares in different business concerns. Disputes arose between assessee and other family members . Thereupon a family arrangement was made between assessee and other family members, whereby assessee had resigned from a partnership firm and transferred his share of profit and loss in said firm to a family member for a consideration of ₹ 35,000 being capital balance of firm.
The Karnataka High Court held that the word ‘transfer’ does not include partition or family settlement as defined under the Act. It is well settled that a partition is not a transfer. What is recorded in a family settlement is nothing but a partition. Every member has an anterior title to the property which is the subject matter of a transaction, that is, partition or a family arrangement. So there is adjustment of shares, crystallization of the respective rights in the family properties and, therefore it cannot be construed as a transfer in the eye of law. Consequently, the Tribunal on a proper consideration of the entire material on record has categorically held that the transaction in question is a family arrangement. When there is no transfer, there is no capital gain and, therefore, there is no liability of the assessee to pay capital gain tax. Therefore, the appeal filed by the revenue was dismissed.
iv. Amount of compensation paid to the assessee to settle inequalities in Partition Capital would not attract capital gain tax. (CIT v. Ashwin Chopra)(Punjab and Haryana HC)
Assessee (Group A) had received compensation from Group B at the time of partition of properties of group of ‘H’ Ltd and that the said amount had been kept in fixed deposit receipts as per the orders passed by the High Court as well as by the Supreme Court. The Assessing Officer considered the family settlement and found that 8.56 per cent of ₹ 24 crore of compensation was the share of the assessee and, consequently, levied long term capital gain on the said amount.
The High Court held that the payment of ₹ 24 crore to Group A is to equalize the inequalities in partition of the assets of ‘H’ Ltd. The amount so paid is immovable property. If such amount is to be treated as income liable to tax, the inequalities would set in as the share of the recipient will diminish to the extent of tax. Since the amount paid during the course of partition is to settle the inequalities in partition, it is deemed to be immovable property. Such amount is not an income liable to tax. Thus, the amount of owelty i.e. compensation deposited by Group B, is to equalize the partition represents immovable property and will not attract capital gain.