Types of trust and their tax treatments
The plethora of litigation, complex, dynamic and ever changing tax provisions are best way to define trust though law maker also attempted to defined 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”
This has three parties, settler who reposed the confidence, trustee who accepted an obligation and beneficiary for whose benefit the same is being done, additionally it should have defined property or subject matter. Most critical of these is beneficiary or beneficiaries and their status play a major role in taxation of the trust.
A. Discretionary & non-discretionary trust – where trustee has discretion to decide on distribution of income and corpus of the trust is discretionary trust and where the settlor prefix the entitlement of each beneficiary are non-discretionary or determinate trust
B. Testamentary & non-testamentary trust- if trust is created with a written deed it is testamentary trust and non-testamentary are created without a written deed
C. Public or private or public cum private trust- In case beneficiaries are public at large viz. charitable or religious trust these are public trust and where beneficiaries are individuals or families are private trust and the combination of two are public cum private trusts. Public trust are not covered under Indian Trust Act and is applicable only to private trusts. Private trust may be created inter vivos or by will. Transfer or gift made during one’s lifetime are inter vivos. If trust is created by will it is subject to Indian Succession Act where rules of succession differ for different religions.
Treatment of trusts under Income Tax Act
Trusts per se are not covered under definition of person u/s 2(31) however reference of trust can be found u/s 2(15), 10(23C), 11, 12A, 12AA, 13, 115BBC, 115TD to 115TF, 160, 161, 164 & 164A, primarily because trust is not a legal entity and tax law wish to use the concept of representative assesee to tax the trust.
Trustee of trust are taxed as representative assessee of the beneficiaries under chapter 15. In general, liability of representative assessee align with liability of person to whom they represent accordingly applicable taxation provisions depends upon type of trust and status of beneficiaries.
Exception to rule that income of trust is taxable in hands of trustee as representative assessee includes
1. When a valid trust is created and property is transferred to the trust, it can’t be revoked and if trust deed has revocation provision then section 60 to 63 applies and income of trust will be taxed in hands of settler or author
2. Section 11 start with ‘subject to provisions of section 60 to 63’ accordingly where a transfer of income is without transfer of asset or transfer is revocable then income stand taxable in the hands of transferor
3. Section 166 overrides the provisions of section 160 to 165, conferring power to AO to assess either representative assessee or directly to person to whom he represent, however once AO has made the choice AO can’t shift the choice.
Applicable tax rates
|Case||Section||Rate of tax||Exceptions|
|A. Non-testamentary or oral trust|
|A.1 Non-testamentary or oral trust||164A||MMR||Note 1|
|B. Testamentary or written trust|
|B.1 Non-discretionary (not having profit & gain from business)||161(1)||Rate applicable to total income of each beneficiary|
|B.2 Non-discretionary (having profit & gain from business)||161(1A)||MMR||Note 2|
|B.3 Discretionary trust||164(1)||MMR||Note 3 & 4|
Note 1- If within three months from the date of declaration of the trust if a statement in writing, signed by the trustee or trustees, setting out the purpose or purposes of the trust, particulars as to the trustee or trustees, the beneficiary or beneficiaries and the trust property, is forwarded to AO it is treated as written trust
Note 2- where such trust is sole trust created under ‘will’ for support and maintenance of dependent relatives
Note 3- where share of beneficiaries is indeterminable or unknown i.e. discretionary not having profit & gain from business exceptions are
a. None of beneficiaries is beneficiary under any other trust or has any other income more than threshold limit or otherwise chargeable at rate more than MMR
b. Such trust is sole trust created under will for support and maintenance of dependent relatives
Note 4- where share of beneficiaries is indeterminable or unknown i.e. discretionary having profit & gain from business exceptions is where such trust is sole trust created under will for support and maintenance of dependent relatives
Where case B.2 and B.3 fall under exception rate applicable will be of AOP i.e. with slab rate benefit instead of MMR
Maximum Marginal Rate (MMR) u/s 2(29C) is rate including surcharge and cess applicable in relation to highest slab of income for individual/AOP/BOI, which is 35.88% for AY19-20 and 42.744% for AY 20-21.
Public Trusts- with respect to part of income not exempt u/s 11 or 12
|Case||Section||Rate of tax||Exceptions|
|A. Income wholly for charitable or religious purposes|
|A.1 Section 13(1) (c or d) not applicable||164(2)||Rate applicable to AOP i.e. slab rate benefit available||Note 5|
|A.2 Section 13(1) (c or d) applicable||Proviso to 164(2)||MMR|
|B. Income in part only for charitable or religious purposes|
|B.1 Section 13(1) (c or d) not applicable|
|B.1.1 Discretionary (not having profit & gain from business)||164(3) & first proviso||MMR||Note 6|
|B.1.2 Discretionary (having profit & gain from business)||164(3) & second proviso||MMR||Note 7|
|B.2 Section 13(1) (c or d) not applicable|
|B.2.1||164(3) & third proviso||MMR||None|
Note 5 section 13(1) (c or d) where income of the trust is directly or indirectly applied for the benefit of any person referred u/s 11(3) or funds of the trust are invested in contravention to section 11(5)
Note 6- where share of beneficiaries is indeterminable or unknown i.e. discretionary not having profit & gain from business exceptions are
1. None of beneficiaries is beneficiary under any other trust or has any other income more than threshold limit or otherwise chargeable at rate more than MMR
2. Such trust is sole trust created under will for support and maintenance of dependent relatives
Note 7- where such trust is sole trust created under ‘will’ for support and maintenance of dependent relative
Where case B.1.1 and B.1.2 fall under exception rate applicable will be of AOP i.e. with slab rate benefit instead of MMR