Legal & Tax aspects of Trusts with i l f t REIT special reference to REITs, INVSTs and AIFs

Presentation by :Dilip V. Lakhani

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CHARTERED ACCOUNTANT

IndexIndex

Legal Provisions – Valid TrustSettlor – Rights, duties and obligationsTrustee – Rights, duties and obligationsg , gBeneficiaries – Rights, duties and obligationsTrust PropertyPrivate Trust - AdvantagesgPrivate Trust - Section 56(2)(vii)Types of TrustStatus of the Trust under ‘the Act’Taxability of Trust Income

Cont …

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IndexIndex

Computation of Total Income and Tax IssuesDisclosure of Status in the return of incomeDouble TaxationContributory TrustREIT - StructureREIT - Tax ProvisionsCase StudyREIT – Retail InvestorsInfrastructure Investment Trust – IITAlternate Investment Fund - AIF

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Legal Provisions – Valid Trust Legal Provisions Valid Trust

The private trust is governed in India by “The Indian Trusts Act, 1882”

TRUST – A Trust is a legal entity created by the Settlor for the benefit of the designated beneficiary under the laws of the State and a valid trust instrument.Thetrustee holds a fiduciary responsibility to manage the trust property and income for the economic benefit of the beneficiarythe economic benefit of the beneficiary.

5 essential ingredients of a valid trust are :

S ttlSettlorTrusteeBeneficiaryTrust PropertyPurpose of the trust

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Settlor – Rights, duties and obligationsSettlor Rights, duties and obligations

Every person who is competent to enter into a contract can be a Settlor

Settlor has right to appoint trustee

Settlor can retain administrative powers in the trust instrument

Once trust is settled, settlor has no obligation or responsibility towards the beneficiary or trustee or the activities of the trust

Under the provisions of Income Tax Act, 1961 (‘the Act’) Settlor is not liable for discharging the tax liability on the income of the Trust – Settlor cannot be treated as a representative assessee

Issue

Whether a Corporate Body can be a Settlor?

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Trustee – Rights, duties and bli tiobligationsEvery person or entity who is competent to enter into a contract can be a Settlor

Trust Property vests in Trustee who will become the legal owner

Trustee has full authority to manage the affairs of the trust subject to the conditions stipulated in the trust deed

Trustee has duties and obligations as per the terms of the trust deed

Trustee can be treated as a representative assessee u/s. 160 of ‘the Act’ and liable to discharge the tax obligation on the income of the Trust

Trustee has a right of reimbursement from the Trust property for the amount incurred or spent for the Trust activity

In case of discretionary trust, the trustee has full authority to decide the ratio of income and trust property to be distributed amongst the beneficiaries

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Beneficiaries – Rights, duties and bli tiobligationsAny living person can be a beneficiary

A corporate body, LLP, Partnership firm, Hindu Undivided Family can be a beneficiary.

An Unborn person can also be a beneficiary – Reference to the provisions of Transfer of Property Act : of Property Act :

Section 5 of Transfer of Property Act – transfer to a living person

Section 13 of Transfer of Property Act – transfer to an unborn person

Section 14 of Transfer of Property Act – rule against perpetuity

Minor can be a beneficiary

Beneficiary has right to receive income and trust property in full or part, depending upon the provisions in trust instrument.

Beneficiary is liable to pay tax on the share of income accruing from trust in case of

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Beneficiary is liable to pay tax on the share of income accruing from trust in case of specific irrevocable trust and give relevant information to the Trustee.

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Trust PropertyTrust Property

Trust Property

Immovable Property

Movable Property

Payment of stamp duty

Registration compulsory

Payment of stamp duty

Registration not

compulsory

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Private Trust - AdvantagesPrivate Trust Advantages

Bankruptcy remote qua Settlor – Trust property does not vest in the Settlor, hence t b tt h dcannot be attached

Avoidance of Estate duty – Inheritance tax (At present in India both the levies are not applicable)

Inheritance planning - Flexibility in transfer of Assets amongst legal heir

Dispute among legal heirs can be avoided by creating Trust - legal heir I can be allotted identified for property

Protect assets with assured income for handicapped or incapacitate family member or Senior Citizen

Tax planning to reduce the tax liability

Avoidance of Probate

Protecting the interest of daughters and lady members of the family against future uncertainties

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uncertainties

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Private Trust - Section 56(2)(vii) Private Trust Section 56(2)(vii)

Case Studyy

Settlor Settlor Settlor

Trustee

(I di id l)

Trustee

(I di id l)Trustee

(Individual)

Beneficiary

(Individual)

Beneficiary

(Corporate Body)

BeneficiaryBeneficiary(Relative of

Settlor)

Beneficiary(Non Relative

of Settlor)

Beneficiary(Non Relative

of Settlor)

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Types of TrustTypes of Trust

Trust

Revocable Irrevocable Revocable Trust

Specific Trust Discretionery T t

Irrevocable Trust

Specific Trust Discretionery T t

Based on the ultimate object the trust can be revocable, irrevocable, specific or discretionary

Incidence of tax depends upon type of Trust

Specific Trust Trust Specific Trust Trust

p p yp

In specific trust share of beneficiaries is determinate

In discretionary trust the share of beneficiaries is not determinate but at the discretion of the trustee income/trust property can be allocated amongst the beneficiaries

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trustee income/trust property can be allocated amongst the beneficiaries

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Status of the Trust under ‘the Act’Status of the Trust under the Act

Whether the status of the trust is “individual”?

Section 2(31) – definition of person

No specific category for Trust

Decisions – status of Trust can be Individual

Food Corpn. of India vs ITO 18 SOT pg.289 (Delhi ITAT)

ACIT vs Guru Trust 57 ITD pg 247 (Bangalore ITAT)ACIT vs Guru Trust 57 ITD pg.247 (Bangalore ITAT)

First ITO vs Radhasaran (P) Religious Trust 17 ITD pg.372 (ITAT Mumbai)

ITO vs S K Family Trust 36 ITD pg.351 (Ahmedabad ITAT)

Whether the status of the trust is “AOP” ?

The word AOP is not defined under ‘the Act’

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The word AOP is not defined under the Act

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Status of the Trust under ‘the Act’Status of the Trust under the Act

Decisions – Test for determination of AOP

CIT vs Indira Balkrishna 39 ITR 546 (SC)

CIT vs. Lakshmidas Devidas 5 ITR 584 (Bom)

CIT vs Dwarkanath Harishchandra Pitale 5 ITR 716 (Bom)

Decisions – Status of Trust can not be AOP.

CIT vs Marsons (Beneficiary Trust) 188 ITR pg.224 (Bombay High Court)

L R Patel Family Trust vs ITO 262 ITR pg 520 (Bombay High Court)L R Patel Family Trust vs ITO 262 ITR pg.520 (Bombay High Court)

CIT vs Babulal Grandson Family Trust 301 ITR pg.271 (Allahabad High Court)

CIT vs Venu Suresh Shila Trust 233 ITR pg 99 (Madras High Court)

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CIT vs Venu Suresh Shila Trust 233 ITR pg.99 (Madras High Court)

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Taxability of Trust IncomeTaxability of Trust Income

Flow Chart Taxation of Specific TrustSpecific Trust

When Trust Income excludes business income

When Trust Income includes business incomebusiness income

(Sec 161)

Income can be assessed in the hands of Trustee as Department has

business income

(Sec 161A)

Maximum marginal rate a representative

assessee as per sec 161

Separate assessments will be made on the trustee

pthe option to make the assessment directly on the beneficiaries as per sec 166

marginal rate will apply

for taxing income of each beneficiary

Tax will be charged at the applicable rate to each beneficiary

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depending upon the tax status

Taxability of Trust IncomeTaxability of Trust Income

Taxation of Discretionary Trust

Income other than Income other than Long Term Capital Gain will be chargeable at Maximum Marginal Rate

Income from Long Term Capital Gain is chargeable @ 20%

Rate

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Taxability of Trust IncomeTaxability of Trust Income

Applicable Sections

Section 160 to 163 - [except Section 161(1A)]Specific trusts – share of benefeciary is identified – assessment can be directly on the beneficiary – AO can assess the Trustees as representative assessee - AO h t d th b fi i ihas to pass as many orders as the beneficiaries

Trustee can be taxed in the like manner and to the same extent, as it would be leviable and recoverable from the person represented by him

Status of the trustee should be the same as that of the beneficiary

Exemptions, Deductions and Abatements available to the beneficiary is to be d h Tgranted to the Trustee

Decisions :CWT vs Nizam Family Trust 108 ITR pg.555

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Abdul Hamid vs CIT vs 156 ITR pg.230

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Taxability of Trust IncomeTaxability of Trust Income

Section 161(1A)

If Trust carried on business then tax is to be charged on the whole of the business income at the maximum marginal rate

Section 164

Discretionary Trust – Share of beneficiary is not determinate – tax is to be charged on the whole of the income at the maximum marginal rate – whether l t it l i i t b t d t i l t f i i l long term capital gains is to be taxed at concessional rate of maximum marginal rate ?

Section 60 to 63

Revocable Transfer – Income to be taxed in the hands of the Settlor / Contributor

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Computation of Total Income and Tax IIssues

In case of revocable Trust carrying on business activity, whether Section 60 to 63 will d S ti 161 (1A)precede Section 161 (1A)

In case of revocable discretionary trust not carrying on business activity whether Section 60 to 63 will precede Section 164

In case of irrevocable Specific Trust if the beneficiary is minor whether provisions of Section 64 will precede Section 161(1)

Th t i i i T t t ti i h th i d b th T t i The contagious issue in Trust taxation is whether income earned by the Trust is :

Business Income or capital gain

Business Income or Income from Other Sources

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Disclosure of Status in the return of iincome

Section 2(31) of `the Act` defines the person.

No specific classification for Trust.

The definition includes “Association of Persons” – the words “Association of Persons” not defined under `the Act`.

The only option available with the Trust is to opt for “Any other AOP/BOI” in the return of income.

In PAN Card application also, the status to be mentioned is AOP.

CBDT Circular No.14(XL-35) dated 11/04/1955

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Double Taxation Double Taxation

Under ‘the Act’ the concept of taxing the same income twice does not subsist

Once income is taxed in the hands of Trustee, post tax distribution cannot be taxed in the hands of beneficiary

If beneficiary is from US or UK subject being Non Resident than the distribution can be taxed in their respective country of residence

Once the AO exercises the option to tax the beneficiary directly then he cannot i t th i i th h d f th t tonce again tax the same income in the hands of the trustees

Decisions :CIT vs Dr. David Joseph 214 ITR pg.658 (Kerala High Court)

Trustees of Chatrabhuj Raghavji Trust vs CIT 50 ITR pg.693 (Bombay High Court)

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CBDT Circular No.157 dated 26/12/1974.

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Contributory Trust Contributory Trust

Contributory Trust means, the trustee has power to accept contribution from the contributors and allocate income, and trust property in the ratio of contributions contributors and allocate income, and trust property in the ratio of contributions

The issue relating to contributory Trust are :

Whether provisions of Section 61 to 63 can apply and income can be taxed in the hands of contributor?contributor?

The contributors come into existence post creation of Trust and share of contributors varies at the end of each financial year. Whether provisions of Section 164 can apply ?

If the status of the contributor is Tax Exempt, E.g. Mutual Funds, IFC Washington, Asian Development Bank etc - how the provisions of S. 60 to 63 will be enforced?

Decisions & Circulars:DCIT vs India Advantage Fund – VII (2015) 67 SOT pg.5 (Bangalore ITAT)

XYZ In Re 224 ITR pg.473 (AAR)

CBDT Circular 45 dated 2/9/1970

CBDT Ci l 281 d t d 22/9/1980 (131 ITR (ST) 4)

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CBDT Circular 281 dated 22/9/1980 (131 ITR (ST) 4)

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REIT - StructureREIT Structure

REIT – Investments through sponsor and contributor.

SponserShare holding

Special purpose vehicle

Ren

tal

inco

me

Real estate investment trust

Property

Invest

s fu

nd

s

Contributor

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REIT - StructureREIT Structure

REIT – Investments through sponsor and contributor

Stamp duty liability can be avoided

REIT Investments through sponsor and contributor.

Rental income will be taxed in the hands of SPV

Dividend distributed by SPV will be subject to dividend distribution tax

In the hands of unit holder the dividend income will be exempt

In the hands of sponsor there will be liability for capital gains depending upon the holding period of the unitsg p

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REIT - StructureREIT Structure

REIT – Investment by Contributors

Contributor

REITRental Income

Property

Stamp duty liability on purchase of property.Rental income will be exempt in the hands of REIT and taxable in the hands of contributor.

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co t buto

REIT - Tax ProvisionsREIT Tax Provisions

Section 2(13A) – REIT is a Trust registered under SEBI (Real Estate Investment Trusts) Regulations, 2014

Units of the REIT to be listed on Stock Exchange

Contributors to REIT will be issued units which will be listed

Long Term Capital Gain on Transfer of Listed Units will be exempt u/s 10(38)

Short Term Capital Gain on Transfer of Listed Units will be taxed @ 15% u/s 111A

I t t i d b REIT f S i l P V hi l ill b t f t Interest received by REIT, from a Special Purpose Vehicle, will be exempt from tax u/s 10(23FC)

Rental Income of REIT will be exempt from tax u/s 10(23FCA)

Any other income of REIT will be chargeable to tax at maximum marginal rate –Section 115UA(2)

Interest Income and Rental Income distributed by REIT will be taxable in the hands of Unit holder – Section 115UA(3) The character of the income in the hands of unit

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of Unit holder – Section 115UA(3). The character of the income in the hands of unit holder will be the same as that in the hands of REIT

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REIT - Tax ProvisionsREIT Tax Provisions

Any other income distributed by REIT to unit holder will be exempt from payment of y y p p ytax, as REIT has paid the tax on the said income

Section 194I and Section 194A will not apply when rental income and interest income is received from Special Purpose Vehicle by REIT

REIT will deduct tax at source @ 10% on interest Income and Rent Income while distributing to unit holder where status is resident – Section 194BA(1)

REIT will deduct tax at the applicable rate while distributing Interest and Rental Income to a Non Resident or a Foreign company – Section 194BA(2)

When the shares of any SPV, as defined under Explanation to Section 10(23FC), is transferred in exchange of units of REIT then at that point of time there is no liability for payment of capital gain – Section 47(xvii)

Such units when transferred will be subject to short term capital gain or long term it l i d di th h ldi i d E if h it li t d th

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capital gain depending upon the holding period. Even if such units are listed, the benefit of Section 10(38) and concession rate of tax u/s. 111A will not apply.

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Case StudyCase Study

Individual Owns property

Company owns property

REIT owns property

Lease Lease

R t l

Lease

R t l Rental Income

Taxable in f

Rental Income

Company Corporate T

Shareholder dividend distribution

Rental Income

Exempt in the hands of REIT

Taxable in the hands of

i h ld

REIT structure is tax efficient as withholding tax provisions do not apply at the time of receipt of Rental Income

No double taxation – Rental Income exempt in the hands of REIT

the hands of Individual

Tax distribution tax REIT unit holder

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REIT - Retail InvestorsREIT Retail Investors

A format that is a globally recognized standard and which is attractive to large scale i tit ti l/ t il i t ld idinstitutional/retail investors worldwide

Low Risk investment model :

Diversification of investment into a pool of properties

Debt limits within the REIT reduce exposure to negative equity risk

Allowing liquidity for investors without impairing security for tenants – investors can sell units in a listed REIT at any time, without the cost and delays involved in selling investment properties

REITs will distribute majority of profits each year - generates a regular income stream for investors

The limits on borrowings also protect the income stream to investors by ensuring h i i h ll ll d d b

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that income is not wholly allocated to debt repayments

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Infrastructure Investment Trust – IITInfrastructure Investment Trust IIT

Section 2(13A) – An Infrastructure Investment Trust is a Trust registered under SEBI (I f t t I t t T t ) R l ti 2014(Infrastructure Investment Trusts) Regulations, 2014

The features and tax issues are identical to the REIT. The provisions discussed under REIT will apply to IIT and the unit holders.

IIT will deduct tax @ 5% while distributing interest to a Non Resident or a Foreign Company – Section 194LBA(2)

IIT ti iti b d th t d diti ti l t d d SEBI IIT can carry on activities based on the terms and conditions stipulated under SEBI Regulations.

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Alternate Investment Fund - AIFAlternate Investment Fund AIF

AIF means any fund established or incorporated in India in the form of a trust or a Li it d Li bilit P t hi b d t hi h h b company or a Limited Liability Partnership or a body corporate which has been

granted a certificate of registration as Category I or a Category II IF and is registered with SEBI – Section 115UB Explanation I(a)

Income of AIF other than Income chargeable under the head “Profits and Gains of Income of AIF, other than Income chargeable under the head Profits and Gains of Human or Profession” is exempt u/s 10(23FBA)

Income under the head “Profits and Gains of Business or Profession” will be chargeable to tax at the rates specified in the Finance Act for relevant year where chargeable to tax at the rates specified in the Finance Act for relevant year, where such fund is a company or a firm and at maximum marginal rate in any other case –Section 115UB(4)

Income accruing to unit holder, which is exempt in the hands of AIF u/s 10(23FBA) o a u g o u o d , s p a ds o u/s 0( 3 )will be chargeable to tax

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Alternate Investment Fund - AIFAlternate Investment Fund AIF

Income accruing to unit holder, which is taxed in the hands of AIF u/s 115UB(4) will b t / 10(23FBB)be exempt u/s 10(23FBB)

AIF will deduct tax at 10% accruing or paying the income due to unit holder which is exempt u/s 10(23FBA). In respect of income which is taxable in the hands of AIF and exempt in the hands of unit holder no tax will be deducted by AIF Section 194LBBexempt in the hands of unit holder no tax will be deducted by AIF – Section 194LBB

Provisions of dividend distribution tax provided in Chapter XII D or XII E will not be applicable while distributing income by AIF to the unit holders.

Payer of Interest will be liable to deduct tax u/s 194A while paying the interest to AIF. Exemption provided u/s 194A(xi) is restricted to Beneficiary Trust only and not applicable to AIF. The payer will deduct tax directly in the name of the unit holder enabling the unit holder to claim the credit of TDS.ab g u o d o a d o S

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Th k YThank You

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