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Assessment of Private Trusts

Note on Private Trusts and their tax implications

 Tax Planning by creating a Private Family Trust

The creation of family trust is a novel method, being adopted, for both tax planning as also planning for dependents marriage, education expenses, etc. As the Gift Tax Act has been abolished, a lot of tax planning is being done by creation of private (family) trusts as, setting up and managing a trust is surprisingly easy, specially, if the trust doesn’t hold any immovable property.

 WHAT ARE PRIVATE TRUSTS?

The Indian Trusts Act, 1882 governs the private trusts and this Act doesn’t apply to public trusts and private charitable trusts. The distinguishing factor, between the private and public trusts is that, in private trusts, the beneficiaries are defined and ascertained individuals, but in public trusts, beneficiaries/interest may be vested in uncertain number and fluctuating body of persons.

A private trust comes into existence when the owner of a particular property (called the ‘Settlor’), while intending to transfer the property to a chosen individual/individuals (the ‘Beneficiaries’) however, doesn’t vest the property with the beneficiaries but vests it with other people (called the ‘Trustees’), who are given the responsibility of ensuring that, the benefits of the property are given to the beneficiaries. For example, a father may be ‘Settlor’ of a trust, who can then make himself and his wife as the ‘Trustees’ and his children as the ‘Beneficiaries’.

the trust doesn’t hold any immovable property.

 POINTS TO BE EXAMINED BY ASSESSING OFFICER

The following points are to be examined, as an Assessing Officer, about the creation of such trusts -

(i) Whether, the subject matter of the trust is certain? If ‘Yes’, whether the person(s) desired to be benefited is certain, and the period of trust has been defined, directly or indirectly.

(ii) The Indian Trust Act doesn’t forbid the ‘beneficiary’ of a trust from being appointed as a ‘trustee’. However, as a general rule, the appointment of a ‘beneficiary’ as a ‘trustee’ is avoided, as there may arise a conflict between his interest and his duty. It was held by the Orissa High Court, in M.C.Mohapatra vs.M.C.Mohapatra that, the same person may be a ‘trustee’ and a ‘beneficiary’.

(iii) Typically, a trust deed should provide the day on which the corpus be distributed among the ‘beneficiaries’. Normally, the ‘settlor’ should mention the last date by which the trust should be wound up and leave it to the discretion of the ‘trustee’ to distribute a part of, or the entire corpus earlier. Under the law, however, the life of such a trust cannot exceed twenty five years. In other words, a private trust should be wound up by a date not later than twenty five years from the date of the creation of the trust. In most cases, however, the corpus is distributed after the children attain majority.

(iv)  The investments, of trust money, are governed by section 20 & section 40 of the Indian Trust Act, 1882. These sections give the details of securities in which investments can be made. However, there is a residuary section 20(f), which says that the ‘trustee’ may invest money in any security expressly authorised by the instrument of trust. The investment clause in the trust deed should be checked, to see if it is suitably drafted, so that full flexibility remains in the hands of ‘trustees’. However, it may be noted that the investment clause is applicable only if the trust has surplus money, which is not immediately required. For fulfilling the objects of the Trust, the investment can be made in any immovable and moveable property.

 CREATION OF PRIVATE TRUSTS

A registered document is necessary to set up a trust, if immovable property is being transferred to it. However, if only moveable property is settled upon the trust, no formal document or agreement, in writing is necessary. It is to be checked if the trust deed has been prepared on a stamp paper, and if so, has it been signed by the ‘settlor’ and the ‘trustees’ in the presence of a witness.

 TYPES OF PRIVATE TRUSTS

A trust may either be a ‘discretionary’ or ‘non-discretionary’ trust. A trust is ‘non-discretionary’ if the shares of the beneficiaries are clearly defined by the ‘settlor’. This is called a “Private Specific Trust” (non-discretionary). In other words, although the trustees have the powers to administer and manage the trust, and its finances, they do not have the discretion to decide the proportion in which the income or the corpus is to be distributed among the beneficiaries. A ‘discretionary’ trust, on the other hand, only specifies the names of the beneficiaries. This is called a “Private Discretionary Trust”. The trustees have complete discretion to decide the proportion in which the income or the corpus is to be distributed, among the beneficiaries. Thus, the trustees may distribute the benefits to just a few beneficiaries (and totally exclude the others) or change the proportion each year or even decide not to distribute the income at all in a given year. In effect, so long as the benefits are passed on to one or more of the beneficiaries named by the ‘settlor’, the trustees have the discretion to decide who among the beneficiaries will benefit from the trust.

 TAXABILITY OF THESE TRUSTS AND THE METHODS OF TAX PLANNING ADOPTED

The taxability of the Trust depends upon the type of the trust. In the case of a non-discretionary trust (Private Specific Trust), all income is taxable in the hands of the beneficiaries. But if the beneficiaries are minors, the income is to be clubbed with that of the parent with the higher income.

On the other hand, in the case of a discretionary trust (Private Discretionary Trust), in which the shares of the beneficiaries are unknown and indeterminate, it is taxed in the hands of trust at the maximum marginal rate.

Thus, in the case of non-discretionary trust, no additional tax planning can be achieved, as the proportionate income or wealth is taxable in the hands of each beneficiary. However, in case of a discretionary trust, tax planning is possible, in the following situations:

(i)                 By creation of such trust through a Will of a person:

If a trust has been created in terms of the Will of a person, and if that is the only trust so declared by him, then such trust enjoys taxation as that of an individual. Suppose, the capital of a deceased person is, say Rs.40 lakhs, which has been mostly invested in loans on which interest of Rs.3.5 lakhs is received each year. On his death, the person wants the capital to be distributed among his wife and one grandson equally. The wife, as well as the parent of the minor, are also having their own income exceeding Rs.8 lakhs each. In this situation, if the assets are distributed directly to the wife and grandson, then both the persons will have additional tax liability of Rs.52,500 each (30% tax on Rs.1,75,000, being half of the interest). Thus, the additional income tax liability comes to Rs.1,05,000 (both put together).

Now suppose, if a trust is being created in terms of Will, as referred above, and trust invests Rs.1 lakh in 80C instruments, the tax liability on the Trust comes to Rs.NIL (at slab rate on Rs.2,50,000 after deducting Rs. 1,00,000, u/s 80C). Thus, there is savings in income tax of Rs.1,05,000 annually. In the above example, if the deceased person had jewellery, of Rs.30 lakhs, and both the beneficiaries had taxable wealth, the wealth tax liability of both the beneficiaries would have increased by Rs.15,000 each. However, by creation of such trust, there can be additional wealth tax savings of around Rs.30,000.

(ii)                Wealth Tax Planning:

Creation of discretionary trust and transfer of taxable wealth tax assets into such trust may give wealth tax benefits. For example, if an individual has jewellery of Rs.60 lakhs, he is liable to pay wealth tax of Rs.30,000. Now, if such individual creates two discretionary trusts, then each such discretionary trusts is entitled to a basic wealth tax exemption limit of Rs.30 lakhs. Thus, if Rs.30 lakhs worth of jewellery is transferred to each of these two trusts, then the total wealth tax liability is reduced from Rs.30,000 each year to “NIL”.

(iii)        Another situation in which creation of such trusts are beneficial is when income of all the beneficiaries are below taxable limit and the beneficiaries are not the beneficiaries of any other trust. In that situation too, the Trust shall be taxable at the slab rates applicable to the individual. After the clubbing provision of minor’s income has been enacted, there is no taxation advantage of minor’s income. Now, a trust may be created in which the minor children may be the beneficiaries, and the parents may be trustees. Thus, the trust shall enjoy the basic exemption limit in both the Income and Wealth Tax Act’s, as also the slab rates applicable for individuals. For example, there are two minors and both are having income of Rs.50,000 each. By virtue of clubbing provisions, the income that will be clubbed in the hands of the parent shall be Rs.97,000 (1,00,000-1500X2), which may have a tax liability of Rs.29,100 (97,000X30%). However, if a trust is created, there wouldn’t have been any clubbing and a tax savings of Rs.29,100 would be made each year.

 ASSESSMENT OF PRIVATE TRUSTS AND THE DATA TO BE CALLED FOR BY AO’s

The step-wise data to be called for by the AO and the incidence of taxation and the tax rates, for the income of the Private Trust, is as under –

1)   Is the Trust

(A) Private Specific Trust or (B) Private Discretionary Trust

(A)         If ”Private Specific Trust” – whether Trust Income includes business income –  (“Yes” or “No”)

(a)          If “Yes” selected –

(1)           whether the business income has been received under a Trust declared by any person, by Will? (“Yes” or “No”)

(2)           whether the Will has been exclusively declared for the benefit of any relative dependent on the settlor, for support  and maintenance (“Yes” or “No”)

(3)           whether this Trust is the only Trust so declared by the settlor (“Yes” or “No”)

(4)          In the Sl.Nos (1) to (3) above, if the option selected is “Yes”, in all the 3 drop downs then, tax is to be charged @ rates applicable to ‘Individuals’, provided (a)none of the beneficiaries have taxable income exceeding Rs.2,50,000 AND (b)none of the beneficiaries is a beneficiary under any other private trust. If any 1 beneficiary has taxable income exceeding Rs.2,50,000 OR is a beneficiary under any other private trust then, the tax is to be charged, in the hands of the Trust, @ MMR, i.e. @30%  

(5)          In the Sl.Nos (1) to (3) above, if the option selected is “No”, in any one or more of the 3 drop downs then, the tax is to be charged, in the hands of the Trust, @ MMR, i.e. @30%, as per Sec.161(1A).

 

(b)         If, against business income, “No” selected – whether the Trust income is being offered in the hands of Trustee(s) [as “representative assessee”] or in the hands of the Beneficiary(ies).

Further, the details of each Beneficiary, viz. Name, PAN, Address, percentage share of each beneficiary, income of the beneficiary (excluding this income), rate of tax applicable to each beneficiary are to be called for.

(1)           If “Trustee(s)” selected then -

(a)          If the shares of all the beneficiaries totals to 100% then, the tax rate to be adopted is the rate applicable to each beneficiary, on the percentage of income of that beneficiary. The tax so computed, for each beneficiary, is to be summed up and this is the tax liability of the “Trust”. (Refer Sec.161)

(b)         If the shares of all the beneficiaries does not total to 100% then, the tax is to be charged, in the hands of the Trust, @ MMR, i.e. @30%, as per Sec.164. 

(2)           If “Beneficiary(ies)” selected then -

(a)          If the shares of all the beneficiaries totals to 100% then, the tax is to be computed as “NIL”, as the income is to be taxed in the hands of the individual beneficiary, as per Sec.166. 

(b)         If the shares of all the beneficiaries does not total to 100% then, the tax is to be charged, in the hands of the Trust, @ MMR, i.e. @30%, as per Sec.164.

 (B)         If “Private Discretionary Trust” selected – whether Trust Income includes business income –  (“Yes” or “No”)

 (a)          If “Yes” selected then, proviso to Sec.164(1) applicable

(1)         whether the business income has been received under a Trust declared by any person, by Will  (“Yes” or “No”)

(2)         whether the Will has been exclusively declared for the benefit of any relative dependent on the settlor, for support  and maintenance  (“Yes” or “No”)

(3)           whether this Trust is the only Trust so declared by the settlor  (“Yes” or “No”)

(4)          In the Sl.Nos (1) to (3) above, if the option selected is “Yes”, in all the 3 drop downs then, tax is to be charged @ rates applicable to ‘Individuals’, provided (a)none of the beneficiaries have taxable income exceeding Rs.2,50,000 AND (b)none of the beneficiaries is a beneficiary under any other private trust. If any 1 beneficiary has taxable income exceeding Rs.2,50,000 OR is a beneficiary under any other private trust then, the tax is to be charged, in the hands of the Trust, @ MMR, i.e. @30%

(5)          In the Sl.Nos (1) to (3) above, if the option selected is “No”, in any one or more of the 3 drop downs then, the tax is to be charged, in the hands of the Trust, @ MMR, i.e. @30%, as per Sec.161(1A).

 

(b)         If against business income, “No” selected – The details of each Beneficiary, viz. Name, PAN, Address, percentage share of each beneficiary, income of the beneficiary (excluding this income), rate of tax applicable to each beneficiary are to be called for. 

(1)         If the shares of all the beneficiaries totals to 100% then, the tax is to be computed as “NIL”, as the income is to be taxed in the hands of the individual beneficiary, as per Sec.166.

(2)         If in the above schedule, the shares of all the beneficiaries does not total to 100% then, the tax is to be charged, in the hands of the Trust @ MMR, i.e. @30%, as per Sec.164.  

 NOTE –

1) In all the above scenarios, where the tax is chargeable at the rates applicable to Individuals, the following additional information is to be captured –

(a)          Whether any of the beneficiaries has taxable income exceeding Rs.2,50,000?

(b)         Whether any of the beneficiaries is a beneficiary under any other private trust?

2) Tax is chargeable at the rates applicable to Individuals for cases where the relevant income is receivable by the trustees on behalf of a provident fund, superannuation fund, gratuity fund or pension fund or any other fund created bona fide by a person carrying on a business or professional exclusively for the benefits of his employees. Hence, this information is also to be captured, by the AO, for the applicable cases.

30
Timir Haran Chakravorty on December 11 2015 12:18:19

Great work. Exhaustive analysis of Private trust. Should be very useful to AO and others.

101
gurunathahs on December 13 2015 21:49:32

Very Good analysis of Private trust. very much use full to me at present as I had a case for disposal. Thanks to Raj sir.

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