February 27, 2021

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Are contributions received voluntarily by private discretionary trust comes within the ambit of taxable income

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This article has been written by Garima Sisodia, pursuing the Certificate Course in Advanced Corporate Taxation from LawSikho.

Table of Contents

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In a current regime of increasing awareness among the people about succession planning by way of trust is increasing drastically over the years. This includes reasons such as a change in the mindset of people who have created sufficient wealth in early 40 -50 years of age or increasing rate of divorce or untimely death/accident or the continuing dispute among the members of the family over the possession of the property. Creating trust is just like a will, however, the basic difference between them is that trust can take place during, at, or after the existence of a  person whereas will can take place only after the death of the person. Under the trust, distribution of assets takes place by the trustees hence matter remains private whereby in the will, distribution of asset is taken by the probate duly appointed by the court, hence family issues come in the public eye. Keeping in mind the other considerations such as stamp duty, income tax associated with creating the trust, one forms a conclusion of setting up the trust.

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Defining Trust

As per section 3 of the Indian Trust Act,1882: trust can be defined as A trust is an obligation annexed to the ownership of the property, and arising out of a confidence reposed in and accepted by the owner or declared and accepted by him, for the benefit of another, or of another and the owner”. Therefore: it is a legal arrangement whereby property both moveable and immoveable is transferred (by the settlor) to the other person(trustee) exclusively for the benefit of a certain group of persons (beneficiary). 

However, the provisions of this act do not cover the state of Jammu and Kashmir and Andaman & Nicobar. It also does not cover aspects such as– 

  • Waqf.
  • Property of Hindu Undivided Family.
  • Public or Private religious as charitable endowments.

Prerequisites of creating a trust

These are the pre-requisites of creating trust:

  • Trust should be formed for lawful purpose.
  • Author should specify its intention of creating trust by action or words.
  • Purpose of the trust.
  • Beneficiary.
  • Transfer of property to the trust.

How trust is formed

The formation of trust involves three elements:

Settlor It is the person who is responsible for creating the trust by way of the non-testamentary instrument in writing or by the way of a will. In the case of immovable property by way of transferring the actual ownership of the property to the trustee. The person who is competent to contract i.e. of sound mind, not declared as insolvent, who is major and if minor then the permission of the court is required.

Trustee – It is the person or group of persons who is responsible for managing the assets of the trust as well as discharging such other functions as laid down in the instrument creating trust. He is the person to whom settlers transfer the property.

Beneficiaries – These are a group of people or individuals who ultimately receives the benefit from the property held under the trust.

Protector – These are the individuals who have been charged with the responsibility of ensuring that trustees are acting in a transparent manner, duly complying with all the duties and rights bestowed on them.

How trust ceases to exist

Under the following circumstances, the trust comes to an end – 

  • When the trust is expressly revoked.
  • When the purpose for which it is formed comes to an end.
  • When its purpose becomes unlawful or fulfilment of which becomes impossible.

Types of trusts

Trust can be private or public. When the objective of creating trust is the charitable or religious purpose then it comes within the ambit of “public trust”. However, when the trust is created for managing the assets of the family systematically and transparently then the concept of “private trust” comes under the picture. 

Based on taxation, private trust is further categorized into two parts– 

  • Specific Trust – Where the shares of the beneficiary are fixed or determinable at the time of creating the trust by the settlor. Illustration – Mr. Sam creates the trust and specifies that each of his two sons will get 50% of income from the trust.
  • Discretionary Trust – Where the shares of the beneficiary are not determined at the time of creating the trust. It depends on the decision of the trustee to allocate the benefits of the trust among various beneficiaries. Illustration – Mr. Sam creates the trust where no specific share of both the sons is mentioned in the deed. The distribution of the share of income is left on the discretion of the trustee.

Taxation Aspects of Private trust

As per explanation to section 164 of the Income Tax Act,1961; if the shares of the beneficiary are not known or are indeterminable at the time of creating the trust or after the formation of trust then in such case tax will be levied at the rate of maximum marginal rate.

On the other hand, according to the section 161(1) of the Income Tax Act,1961; if the shares of the beneficiaries are known then in such case trust would be liable to tax for income other than business income in the same manner as if the income is chargeable in the hands of the beneficiaries. For the purpose of business income, tax is levied at the rate of maximum marginal rate.

The Commissioner of Income-tax, Chennai Vs Shriram Ownership Trust

Issue  

Whether the private discretionary trust is to be assessed as an individual or association of person.

Facts

The respondent is a private discretionary trust which filed its return of income in Form ITR – 5(As an Association of person) for the assessment year under consideration 2014-15. However, the primary issue of concern was that it has received Rupees 25 crore from six of its group companies and the same has been considered as a voluntary corpus credited to the balance sheet under the head” addition to corpus” and the same is not liable to income tax.

Judgment 

The High Court of Judicature at Madras held that referring to the judgment laid down by the honourable Supreme Court in case CIT vs. Indira Balkrishna where the term “Association of person” is dealt with in-depth. Accordingly, an association of persons is the one where a group of persons comes together to form an association to undertake some action. In the present issue, it is evident that trust has been created by the trust for the sole benefit of the beneficiaries who are individuals. It further held that beneficiaries have not come together to undertake some action but are just the part of trust eligible for securing the benefit arising from the trust.

Further, it held that according to section 56(1) of the Income Tax Act,1961; any income which is not excluded from the total income will form the part of “Income from other sources” if it doesn’t fall in any other head.

Further, according to the details mentioned under the Trust deed and Supplemental Deed it is clearly mentioned that trust is for the benefit of members of owner groups and the senior leadership group of Shriram Group which clearly reflects the fact that beneficiaries are identified.

According to section 160(1)(iv) of the Income Tax Act,1961, the term representative person can be defined as in respect of any income which is received by the trustee on behalf of the beneficiaries. then in such case for the purpose of such income, the trustee would be considered as a “representative assessee”.

According to section 56(2)(vii) read with the explanation inserted to section 2(31) of the Income Tax Act,1961 which says any sum of money for property received by a person will be liable to tax under the head “Income from other sources whereby person includes individual. Therefore, the court held that the assessee trust is a representative assessee representing the beneficiaries who are identified individuals and therefore to be assessed as “individual. Hence, the income of rupees 25 crores to be considered as “Income from other sources.”

Private trust whether specific or discretionary in nature falls within the ambit of the taxation. The sole purpose of forming the trust and transferring the property to another person acting as the trustee is to avoid the disputes which may occur in future with respect to the possession of the family property. At the same time, it allows for effective control over the property. In brief, it can be said that in case of specific private trust where shares of beneficiaries are ascertainable, income other than business income would be taxable in the hands of trust who is acting in a representative capacity in the same manner as it would have been chargeable in the hands of beneficiaries. Whereas, in case of discretionary private trust where shares of the beneficiaries are not known then in such case the tax is levied at the maximum marginal rate. Therefore, any contribution received by the trust voluntarily would be taxable depending upon the nature of the same.


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