Executive Summary
Private Trusts are the effective vehicle for transfer of family assets and succession planning. Such vehicles avoid dispute among the family members and ensure transfer of assets in the fair and transparent manner. Such trust is common among wealthy business families of India. Under this type of structure, the property is transferred from one person to the trust and is held for the benefit of another person. In this article we will analysis the basics of private trust and its taxation.
Introduction
Indian Trust Act, 1882 is the governing statue for the Private trust. The preamble of the Act reads as “An Act to define and amend the law relating to Private Trusts and Trustees.”
Private trust is created for the benefit of specified individual or individuals. The individual may be family members, relative or the friends.
Section 3 of the Indian Trust Act 1882, defines private trust as A “trust” is an obligation annexed to the ownership of 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, private trust is an obligation with respect to ownership of the property. Trust is not the separate legal entity. Imposition of Confidence, transfer of property, benefit of another are the essential elements of the private trust.
Concept of Private Trust
Below example will provide the overview of the basic structure of the private trust.
Example- Mr A is engaged in the business of trading of diamonds. He has two daughters Ms. X and Ms. Y. In order to ensure proper maintenance and education of his daughter he created a trust and transfer a part of his property to the trust. The property under the trust will be applied for the purpose of education and maintenance of the daughter of Mr. A. Mr B who is the manger of Mr A is given the responsibility to ensure proper utilization of the trust property.
Therefore, in this case, the trust created by Mr A will be private trust because.
- There is transfer of property from Mr A to the trust.
- Confidence is imposed upon Mr B for application of the property. Mr B will be under obligation to ensure fair utilization of the property.
- Property will be held for the benefit of specified individuals
Parties Involved in trust.
With reference to the above example, below are the parties involved in the private trust.
- Author/Settlor/Trustor– the person who transfer the property to the trust. Mr A is Author in this case.
- Trustee– the person who accepts confidence and obligation. Mr B is the Trustee.
- Beneficiary– The person for whose benefits the property is held. Daughters of Mr A- Ms X and Ms Y will be the beneficiary in this case.
Why private trust
Private Family trust are the effective and efficient tool for managing and transferring the family assets. Some of the important benefits of such trust are as follow:
- Trust is administered and governed by the trust deed which specifies rights of each beneficiary. Such trust deed avoids the disputes among the family members.
- Structure of trust requires appointment of trustee. In many cases professional persons such as bankers, corporates are appointed as the trustee and settlor can become the co-trustee. Such type of arrangements helps in better management of trust.
- Once the assets are transferred to the trust, settlor loses the ownership rights of the property and it vest with the trust. Therefore, in the event of insolvency, creditors cannot claim the assets of the trust. Note that this will be subject the provisions of the Insolvency law as there are special provisions for the undervalued transactions.
Important Concepts About trust
1. Public trust v/s Private trust
The basic difference between the public trust and the private trust is the beneficiary of the trust. In case of private trust, the beneficiary and identified and mostly they are family members only. In some cases, the trust may also be created for the benefit of employees of the company.
On contrary public trust is created for the benefit of society at large. There are no restrictions on the beneficiary of the trust. Public at large is the beneficiary of the trust. Educational and religious trust are the examples of public charitable trust.
2. Revocable vs Irrevocable trust
Section 63 of the Income Tax Act, 1961 provides the distinction between the revocable and irrevocable trust. It provides that trust shall be deemed to be revocable –
- If it contains the provision of transfer of whole or part of assets and income of the property back to the transferor. Note that such transfer may be directly or indirectly.
- Or it gives transferor the right to reassume power over the asset either whole or part, directly or indirectly.
All the other trust will be irrevocable trust. Revocable and Irrevocable trust are essential to determine the taxability of the trust and also for the clubbing of the income.
3. Trust Deed
Trust deed is the governing instrument for the trust. Just like Memorandum and Article of Association governs the company, trust deed governs the trust. Trust deed shall be made in writing in case immovable property is transferred under the trust. Trust deed in writing is not required in case of transfer of movable property.
However, it is always advisable to have the trust deed in writing to avoid any disputes that may arise.
In case the private trust is created under the will, trust deed shall be in writing because the succession laws require will to be in writing.
4. Extinction of the Trust
A private trust may be extinct that is dissolved in the following cases,
1. By the Author/Settlor- Settlor may reserve the express rights in the trust deed for the extinction or the revocation of the trust.
2. By the Beneficiary- Beneficiary of the trust may at any time relinquish their rights under the trust and the trust cease to exist.
3. In case the trust is created for the specific purpose and the purpose is fulfilled. This is also applicable when the trust is created for the specified period of the time and the time is expired.
4. When the purpose of the trust become unlawful.
5. When fulfilment of purpose become impossible due to destruction of trust property or otherwise.
Income tax Act
Section 2(31) of the Income Tax Act, 1961 defines the “person” and provides that person includes every artificial judicial person. Further Explanation 1 to the clause provides that such artificial judicial persons shall be deemed to be person whether or not there is element of profit. Therefore, Private trust shall be deemed to be Person for the purpose of Income Tax Act.
Income Tax Act contains special provisions of the taxability of the trust. These are as follows.
1. Section 61– Revocable transfer of Assets
Section 61 of the Act provides that income arising from any revocable transfer of the asset shall be clubbed in the hands of transferor only. For example- Mr A made the revocable transfer of house property to the private trust. In this case, rent arising from the house property will be taxed in the hands of Mr A only.
It may happen that an asset is transferred by way of trust and power to revoke the same arise after some time like on death of beneficiary. In such case clubbing provision will be applicable as an when power to revoke arises that is on the death of the beneficiary.
2. Section 64(1)(vii)/(viii)- Indirect transfer for benefit of spouse/son’s wife
This section provides that when an individual transfer any asset directly or indirectly to any person or association of persons for the immediate or deferred benefit of his/her spouse of son’s wife, income from such assets will be clubbed in hands of transferor only. Note that this provision will be applicable only when transfer is made for inadequate consideration.
For Example- Mr A transfer the Land having fair market value of Rs 1 Cr to the private trust without consideration. Annual rental of the land is Rs 3 lakhs. The trust is created for the benefit of spouse of Mr A. In such case, rental income from land will be taxable in the hands of Mr A only by virtue of Section 64(1)(vii).
3. Gift taxation and Capital Gains
Section 56(2)(x)- Section 56(2)(x) provides for the taxability of gifts. It provides that whereas any person receives any sum of money, any movable or immovable property without adequate consideration, then in such case the receipt will be treated as the income of the recipient subject to provision of this section.
Now the question arises, whether the gift taxation will arise on transfer of property from the settlor to the trust because such transfer are usually made without consideration.
In such case, section 56(2)(x) inter-alia provides certain cases where taxability does not arises. Among other cases one of the cases is regarding private trust.
It provides that, if the trust receives any property without the consideration from any individual, taxability does not arises provide the trust is created for the benefit of the relative of the individuals.
For Example- Mr ABC creates a private trust for the benefit of his son XYZ and transfer property to the said trust. Now since the trust is created for the benefit of relatives of Mr ABC, the transaction will be outside the preview of Section 56(2)(x) and no taxability will arise in case of trust.
Now the question arises about the taxability in hands of Mr ABC. Since Mr ABC transfer the property to trust, the said transaction may attract the capital gain tax.
Section 47 of the Act provides certain transaction which will not be regarded as the transfer. Since capital gain tax arises only on transfer of capital asset, no capital gain tax will arise in case of transaction covered by section 47 because these transactions are not classified as transfer.
Section 47(iii) provides that any transfer of capital asset by way of irrevocable trust will not be regarded as transfer.
Therefore, Mr ABC will not be required to pay any capital gain tax on the said transaction provided that the transfer is not revocable.
4. Tax Rates for Private Trust
Section 161 and section 164 provides for the tax rates for the Private trust. Tax rate depends on the fact whether the share of beneficiaries is determined or know. Below are the tax rates applicable.
1. Rate Applicable to total income of each beneficiary- In case share of beneficiary are determined and trust does not include any income under the head “Profits and Gains from Business & profession”.
2. Rate applicable to AOP: Income of the trust will be taxed at the rate applicable to the AOP in below cases.
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- Trust has the income under the head “Profits and Gains from Business & profession” and trust is declared by way of will and created exclusively for the benefit of dependent relative is it is only trust declared by the settlor.
This will be applicable whether the shares of beneficiary are determined or not.
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- Trust does not include any income under the head “Profits and Gains from Business & profession” and it falls in below cases.
- Income of none of the beneficiary exceeds the maximum amount not chargeable to tax.
- Trust is declared by way of will and it is the only trust declared by settlor.
- Employer welfare fund created for the benefit of the employees.
3. MMR- In all other cases, tax will be charged at Maximum Marginal Rate of Tax.
Frequently Asked Questions
Q.1 Whether Trust is required to have PAN
Ans: Trust is the separate person under the income tax act and therefore required to have the separate PAN- Permanent Account Number. Trustee of the Trust shall make the application on behalf of trust.
Q.2 Whether trust is required to file Return of Income
Ans: Section 139(1) provides that every person other than company and firm are required to files their return of income if the income of said person without giving effect of specified deductions exceeds maximum amount not chargeable to tax. Further, seventh proviso to section 139(1) provides specified cases where filing of return of income is mandatory. Accordingly, the trust is required to file its return of income if it falls into these criteria.
Q.3 Whether trust can become member in any company and partnership firm
Ans: Trust is basically an obligation and confidence imposed upon the trustee. It does not have any separate legal structure unlike companies. Therefore, trust cannot become the member in the company in its own name. However, trust can hold securities in any company or body corporate through its trustee.
Further, Companies Act 2013 is silent on the aspect whether trust can become the member of the company. Companies Act 1956 provides that trust cannot become member of company directly, it can become the member through its trustees.
The same principal would be applicable in case of Partnership firms and the LLP.
It should be ensured that there are express provisions in the trust deed that empowers the trust to have the interest in the partnership firm and the company.
Q.4 What happened on death of the trustee.
Ans: Section 73 of the Indian Trust Act, 1882 provides the detailed guidance in case of death of trustee. It provides that person nominated for this purpose in trust deed will appoint new trustee. In case there is no person appointed as such, author of the trust or the surviving and continuing trustee or their legal representative will appoint the new trustee.
Section 74 further provides that the beneficiary can approach the court for the appointment of new trustee if the appointment is not possible u/s. 73.
Note: Section 73 is also applicable in case of insolvency, discharge of trustee or when trustee become unfit.
Q.5 Whether trust can buy and hold the properties
Ans: As specified earlier, trust is the obligation and not a separate legal person. The trust is holding the properties through its trustees for the benefit of the beneficiary. Therefore, trustee can buy and hold the properties subject to the provisions of the trust deed.
Q.6 Whether trust properties can be attached to settle tax and other liabilities of Settlor or trust.
Ans: Section 281B of the income tax Act provides for the provisional attachment of the property of the assessee. This section provides that the property belonging to the assessee may be attached provisionally to protect the interest of the revenue.
Further section 281 provides that in case assessee make any transfer or property during the pendency or after completion of any proceedings, assessing officer may declare such transaction as void. Note that the transaction cannot be declared void if it is made with adequate consideration.
On the combined reading of the above provisions, it can be concluded that the Tax Authorities cannot attach the property belonging to the trust to recover the dues belonging to the settlor because section 281B provides that only property belonging to the assessee can be attached.
However as per section 281, in below cases, transfer of property from settlor of trust to trust can be declared void and they will be then deemed to be property of the settlor and can be attached.
Transfer has been made without adequate consideration during the pendency of any proceedings or completion of the proceedings.
Author Bio
The article does not cover as to what will be Income tax liability as and when the property, movable or immovable, are distributed to the Beneficiaries of the Trust upon dissolution of Trust on fulfillment of conditions mentioned in Trust Deed. This question should also be dealt with.