Taxation of Family Trusts and Foreign Trusts in India

CA. Divakar Vijayasarathy

DVS Advisors LLPIndia-Singapore-London-Dubai-Malaysia-Africa

www.dvsca.com

Presentation Schema

Understanding Trusts

Trust Regulations

Parties to Trust Constituents of

Family Trust

Types of TrustsWhy to Form a

Family TrustFormation of Family Trust

Taxation of Family Trusts

Foreign Trusts and its Taxation

CaveatsJudicial

PrecedentsPractical Issues and Questions

Trusts??

Understanding Trusts

• A legal obligation annexed to the ownership of the property

• Confidence reposed by settlor in trustee for the benefit of beneficiaries

• Fiduciary arrangement between the parties of trust

• Not a separate legal entity

• Beneficiaries being relatives of settlor – “Family Trusts”.

Trust Regulations

• Formation and Functioning - Indian Trust Act, 1882

• Focuses majorly on Private trusts

• Extends to whole of India except the State of Jammu & Kashmir and Andaman & Nicobar Islands

• Not applicable to Waqf (Muslim endowment to a religious or charitable cause), HUFs, charitable endowments

governed by special legislations

Allied Legislations

• The Indian Trusts Act, 1882

• The Constitution of India

• The Code of Civil Procedure, 1908

• The Indian Stamp Act, 1899 as amended by the relevant State Governments

• The Specific Relief Act, 1963

• The Limitation Act, 1963

• The Income Tax Act, 1961

Parties to Trust (Sec 3)

BeneficiariesPerson for whose benefit the confidence is accepted

TrusteePerson who accepts the confidence and is responsible to implement the settlor’s

intentions

SettlorPerson who reposes or declares the confidence in trust

Constituents of Family Trust (Sec 6)

Requirements of Valid Trust

Intentions of settlor to create a trust

The trust property

Purpose of the trust

Beneficiaries (relatives of settlor)

Types of Trusts

• Discretionary Trust – Trustee having complete discretion

• Non-discretionary Trust – Share of beneficiaries are clearly defined

Private Trust – for benefit of specific individuals

• Charitable Trust – Charity and charitable intent, serving “public purpose”Public Trust – benefit for general

public at large

• Revocable Trust – Settlor can revoke anytime

• Irrevocable Trust - Cannot be revoked after creation

Non-testamentary Trust - effective on occurrence of specific event

• Trust created by a testamentary instrument, effective only after the death of the settlorTestamentary Trust

• Constructive Trusts – Imposed by court to avoid unjust enrichmentImplied Trust - created by act and

conduct of Parties

• Trust created in express terms embodied in trust deedExpress Trust

Why to Form a Family Trust

Benefits of relatives

Protecting own interest

Preventing alienation of

properties

Peaceful distribution

of estate

Formation of Family Trust

Identification of Trustee and Beneficiaries

• List of relatives by settlor

Identification and Transfer of

Asset

• Movable as well as immovable properties

• Separate procedures for every class of asset

• Transfer of immovable property – trust deed mandatory (Sec 5)

Preparation and Validation of Trust Deed

• Deed containing points of acknowledgement of trust properties, objects, tenure, consequences in case of death of trustee, etc

• Executing on stamp paper, signature of witnesses, submission with Local Registrar

Practical Relevance of Family Trusts

• Wealth Management

• Tax Planning

• Estate Planning

• Consolidation of family assets

• Prevention of future alienation of family assets

• Realignment of family assets

Taxation of Private Specified Family Trust (Section 161(1) and 161(1A))

Trust income

Includes business income

Whole income at MMR

At rate of AOP if:-

- Trust created through will and

- Exclusively for dependent relative and

- Only trust created by settlor

Does not includes business income

Taxable in the hands of trustee –rate applicable to each beneficiary

shall apply to income of trust. (Section 166) Alternatively, AO can

assess income in the hands of beneficiaries

Taxation of Private Discretionary Family Trust (Sec 164(1))

Trust income

Includes business income

At rate of AOP if:-

- Trust created through will and

- Exclusively for dependent relative

and

- Only trust created by settlor

Whole income at MMR

Does not include business income

At rate of AOP if:-

- Beneficiaries have other income less than basic exemption limit (“BEL”) and are not beneficiaries in other trust or

- Trust created through will and it is the only trust created by settlor or

- Trust is non-testamentary trust created before 01.03.1970 for exclusive benefits of dependent relatives or

- Trust created on behalf of any funds for benefits of employee

Taxation of AOP (Sec 167B)

When shares of member are determinable

Income of member Tax

No member having more than BEL

Slab rates

Any member having more than BEL

MMR

Any member taxed at higher rate than MMR

On such portion relating to AOP – such higher rateOn balance - MMR

When shares of member are indeterminable

Tax on total income – tax @ MMRAny member charged at rate higher than MMR – tax @ such higher rate

Taxation of Grantor/Settlor

• No tax shall be assessable on the Grantor

• However where the trust is for the immediate or deferred benefit of the spouse and minor child – the individual shall be liable to tax to the extent of their share of income from the trust

Share of Income of the Beneficiary – Sec 67A

Where shares are determined under Sec 67A

• Share of each beneficiary shall be proportionately computed

• Income shall be part of the personal income under the respective heads of income

Taxation in the hands of Beneficiary (Sec 86)Chargeability of AOP Taxation of share of profit

MMR or higher rate Not included in total income – no tax

Slab rates Included in total income – rebate available on entire share –effectively no tax

Not taxed at all Included in total income – tax applicable

Foreign Trusts

Trust created outside India

Governed by laws of foreign countries

Settlor, Trustee or beneficiaries may or

may not be resident or citizen of foreign

country

Taxation of Foreign Trusts

Foreign Trusts

Revocable Trust

Irrevocable Trust

Income not accruing or arising in India

Income accruing or arising in India

No taxability

Indian Settlor

Taxable in the hands of settlor

Foreign Settlor

Taxability shall depend on status of beneficiaries

All beneficiaries -Indian resident

Trust shall be treated as AOP in India – world income taxable - foreign trustee shall be representative assessee

Trustee being in or controlling from India

Mix of Indian and non-resident beneficiaries

Indian beneficiaries taxed on distribution from trust

Caveats

• Relative for the purpose of taxation - spouse, brother, sister, any lineal ascendant or descendant

• No BEL available when taxability at MMR

• Prescribed special rates applicable for special incomes e.g. Sec 111A, Sec 112

• Indian resident beneficiaries required to report their interests in foreign trusts

Judicial Precedents

Character of discretionary trust cannot be changed by resolution passed by trustees –Commissioner of Income Tax vs. Ambalal Sarabhai D. Trust No. 5 [1998] 231 ITR 540 (Gujarat)

It is not open to the Assessing Officer to disregard the rectification of a trust deed, when it is done by order of a City Civil Court though such order would operate only prospectively – Commissioner of Income Tax vs. Kamla Town Trust [1996] 84 taxmann 248 (Supreme Court)

In case of trust where individuals are beneficiaries, the trust has to be treated as individual and hence deduction of TDS to be done accordingly – Commissioner of Income-tax-XVII vs. Food Corporation of India, Contributory Provident Fund Trust [2009] 177 taxmann 224 (Delhi)

Where a trust is created for the deferred benefit of a minor child by accumulating the income of the trust until such time the minor attains majority, clubbing provisions shall not be applicable -Commissioner of Income-tax vs. M R Doshi [1996] 85 taxmann 591 (Supreme Court)

Practical Issues

• Revocable Family Trust – issues regarding properties transferred being available for the creditors of the settlor

• Exemptions from capital gains tax under the Act – Not available for private trusts, etc.(interpretation issue)

• Sec 115BBDA of the Act – Double taxation on receipt as well as distribution

Few Questions

Whether settlor himself/herself can be trustee in trust?

Whether relatives of trustees can be beneficiaries to the trust?

Whether trustee’s personal assets can be utilised to make good the loss on account of breach of trust?

Whether settlor can vest property to trust which has on-going debt, with an availability clause (in Trust Deed) of utilisation only after the debt gets cleared?

In case of trusts other than irrevocable trusts, what will happen if in case the settlor is discharged as insolvent or bankrupt after creation of trust?

In case of death of beneficiaries, whether benefits available to beneficiaries shall directly be available to their legal heirs or successors?

Whether distribution of income by trust to the beneficiaries would get hit by Sec 56(2)(x) of the Act?

Thank YouDVS Advisors LLP

India-Singapore-London-Dubai-Malaysia-Africa

www.dvsca.com

Research Credits – Kavitha Divakar & CA Jugal Gala

Copyrights © 2019 DVS Advisors LLP

Credits and AcknowledgmentsJugal Gala

DVS Research Team