Creation and Taxation of Private Trusts

Introduction: A Private Trust is said to be an instrument of safeguarding the interests of beneficiaries especially when the beneficiaries are minor and not capable of protecting their interest.

Any person who is a major and is competent to enter into a contract can be a settler or the person intending to form a trust. In the below given paragraphs the authors have tried to itemize the fundamentals of formation of a private trust and the way it is brought to taxation under India Income Tax Act, 1961.

It is advised that the readers should take proper care and consultation before acting on the material contained in this article.

1. Why to create a private trust?

A Private trust is created for the following reasons:

Figure 1. Why to create a private trust

Figure 2-working of private trust

2. How to register a trust:

o If trust property happens to be immovable property: A registered document (trust deed) is necessary to set up a trust if immovable property is being transferred to it. The deed should be made out on stamp paper (for stamp duty consult your civil lawyer) and registered with the Registrar of Assurances under the Registration Act.

o If trust property happens to be movable property

If only movable property is settled upon the trust, no formal document or written agreement is necessary. All the same, it’s advisable to prepare a trust deed on a stamp paper and have it signed by the settlor and the trustees in the presence of a witness to avoid any subsequent disputes.

o Once the trust is set up, the settlor can contribute more funds to it as and when he wants to. Even trustees, as also friends and relatives, can gift funds to a trust. Since gift tax has been abolished, no such tax is payable on the amount gifted to the trust.

3. FAQs (frequently asked questions about trust)

1. What is a trust?

1. A Trust is a transfer of property of a person to another with the intention that it is administered for the benefit of the owner and/ or others.

2. The person who transfers the property is called a “Settlor” or “Author of the trust” and

3. The person to whom the property is transferred is called the Trustee.

4. The person for whose benefit the trust is created is called the “beneficiary”.

5. The property transferred for the trust is called the “Trust Property”.

2. How a trust can be created?

A Trust is created when the Settlor indicates his intention to create a trust. In order to create a trust you must

• Clearly specify the trust property,
• The purpose of the trust and
• The beneficiaries of the Trust.

3. Who can create a trust i.e. who can be a settler?

Any person

• Who is a major, not legally insane, insolvent or a minor may create a trust.
• However a minor can create a Trust with the permission of Court.

4. Who can be appointed as a trustee?

A trustee is a person,

• To whom the settlor transfers his property.
• Anyone can be a trustee, but if he has to administer the properties of the trust, then he should be eligible to enter into contracts.
• A minor, insolvent or an insane person cannot be a trustee.
• A person has the right to reject his trusteeship.
• If a person accepts the trusteeship voluntarily, according to reasonable terms he becomes a trustee and assumes all the rights, liabilities and duties of a trustee.

5. Whether unlawful purpose can be an object to create at trust?

A” gives some ships to “B” to carry on smuggling business and use the profits arising out of it for maintaining A’s children. Is the Trust valid?

The Trust is not valid because a Trust can be created only for a lawful purpose.

6. What can be treated as trust property?

Trust property can be moveable or immovable property.

1. If the trust constitutes immovable property then its transfer to the trustee must be through a written and registered document, signed by the settlor.

2. If the trust constitutes moveable property, delivery of such property to the trustee is enough and there is no need for a written document.

7. What are the rights of a trustee?

The following are the rights of a trustee:

1. To have possession of the trust property.

2. To get reimbursement of expenses incurred in maintaining the trust property.

3. To apply to the court, for its opinion, advice or direction in the management of the trust property.

4. To have the accounts of the trust property examined and settled on completion of the duties.

On completion of his duties, to have a written acknowledgement from the beneficiaries saying there are no dues from him to the beneficiaries.

8. What are the powers of the trustee?

The trustee is empowered to take action for the welfare of the trust property to:

1. sell the trust property together or in lots, by public auction or private contract. This can be sold together or at different times.

2. Do the above within a reasonable time, i.e. sell the property and invest the trust money to purchase any other property.

3. Convey the trust property through a valid and registered sale deed.

4. Invest the trust money and monitor the investments.

5. Use the trust property for the maintenance, education or advancement of a minor beneficiary, if any.

6. Give a written receipt for any money, securities or other movable property, which is paid, transferred or delivered, to him.

When there are two or more trustees, any one may be authorized to execute the trust. In that case the authorized trustee can:

1. Accept security for a debt,

2. Allow time for payment of a debt,

3. Compromise, abandon, submit to arbitration or settle any debt relating to the trust.

9. What are the disabilities of trustees?

The disabilities of a trustee are:

1. Once he has accepted the trust; he cannot refuse to act as a trustee.

2. A trustee cannot delegate his duties to another or a co- trustee.

3. A trustee should not use the trust property for his own profit or any other purpose, unconnected with the trust.

4. A trustee cannot buy the trust property on his own account or as an agent of a third person.

5. A trustee cannot act unilaterally but must consult his co-trustees, if any.

6. Co-trustees should not lend the trust money to each other

10. How does a trust cease to exist?

A trust ceases to exist:

1. When its purpose is completely fulfilled; or

2. When its purpose becomes unlawful; or

3. When the fulfillment of its purpose becomes impossible by destruction of the trust property or by any other cause; or

4. When the trust is expressly revoked.

11. What are the rights of a beneficiary?

The beneficiary has the right to:

1. Enjoy the rents and profits of the trust property.

2. Expect the trustee to transfer the trust property to one or more beneficiary.

3. Inspect and take copies of the instrument of trust, the documents relating to trust property and the accounts of the trust property.

4. If for any reason the execution of the trust by the trustee becomes impracticable the beneficiary may institute a suit for the execution of the trust.

5. To expect the trustee to properly protect and administer the trust property.

6. To compel the trustee to perform his duty properly.

7. To transfer the benefits arising out of the trust to any other person after the beneficiary attains majority.

12. How a trust can be revoked?

When a trust is created by will, it is revocable at the pleasure of the testator, because it does not become effective during the lifetime of the testator.

Any other trust can be revoked in the following ways:

1. By the consent of all the beneficiaries.

2. By the settlor in exercise of powers of revocation expressly reserved to him.

3. If the trust was created for repayment of debts, the settlor can revoke the trust at any time irrespective of whether the debt is repaid or not. However, if the debt is not repaid and the creditor has knowledge of the creation of the trust, then, the trust cannot be revoked without the consent of the creditor.

4. Taxation of private trusts:

Income from private trusts is available to specified beneficiaries and not the public at large. Private trusts are of two basic types for Income tax purposes:

• Specific trusts– where the individual shares of the beneficiaries are known and ascertainable for e.g. Mr. X creates a trust for his 5 sons and the share of each son is mentioned in the deed as 20% each, then such trust is known as specific trust.
• Discretionary Trust: In this no individual shares of the beneficiaries are mentioned in the deed and income is distributed to them on the “discretion” of the trustee.

Needs for creating a private trust?

Trusts are created for multifarious purposes though the major reasons being the following:

• To hold property for present or future needs of dependents and family members. A common example is a trust that provides for the accumulation of income and capital for specified infant children. Subject to their maintenance during this period, the accumulation must be handed over to them upon their attaining a specified age or, in the case of a female beneficiary, upon marriage; and
• Sometimes to reduce the burden of tax.
• Retirement trusts are commonly set up be employers to provide retirement benefits to employees

Tax treatment of trusts:

• Approved retirement trusts are also exempt from tax.
• In the case of private trusts, if the individual shares of the beneficiaries are ascertainable, they are included in the individual taxable incomes, the tax assessment being made either directly on the beneficiary or on the trustee as a representative of the beneficiary. However, if the trust has income from business, the entire income from the trust is taxed in the hands of the trustee at the maximum marginal rate applicable to individuals unless the trust is created by will for the benefit of relatives. When the individual shares of the beneficiaries are indeterminate (i.e., discretionary trust), the entire income is taxed in the hands of the trustees, in most cases at the maximum marginal rate applicable to individuals.

See the diagram below for better understanding:

Notes:

Point 1: in the following case rates applicable to Individuals will be charged:

• If the trust has been declared by way of a will from which business income is derived; and
• It is exclusively declared for the benefit of any relative dependent on the settlor for support and maintenance; and
• The trust is the only trust so declared by the settlor.

Point 2: in the following cases rates applicable to Individuals will be charged:

1. Where none of the beneficiaries

• Has taxable income exceeding the maximum amount not chargeable to tax

• Is a beneficiary under any other private trust; or

2. Where the relevant income or part of the relevant income is receivable under a trust declared by any person by will and such trust is the only trust so declared by him; or

3. Where the trust yielding the relevant income or part thereof was created by a non-testamentary instrument before 1-3-1970 and the A.O. is satisfied that it was created bona fide for the benefit of the dependant relatives of the settlor, or where the settlor is HUF, exclusively for the benefit of the dependant members.

4. 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.

Tax treatment of settlor / grantor

• If the trust effectively alienates income from the settlor/grantor, income tax liability thereon will be avoided.
• However, the settlor/grantor continues to be liable to income tax on income from the settled property to the extent that it is for the immediate or deferred benefit of a spouse or minor child.
• Stamp duty is payable on the transfer of immovable property.

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Authored By-

1. M. K. Shah Advocate  2.  CA Bhupesh Kumar Shah

11/3, Butler Road, Dalibagh, Lucknow- 226001

Email- [email protected]

Author 1 is a practicing income tax lawyer at Lucknow-UP

Author 2 is a member of the institute of Chartered Accountants of India

(Republished With Amendments)