Tax

Taxation of Private Trusts When the shares of the individual beneficiaries are determinate:-  The shares falling to each of the beneficiaries are liable to be assessed, either in the hands of the trustee(s) as a representative assessee or directly in the hands of the beneficiary entitled to the income. Such assessment is made at the rate applicable to the total income of each beneficiary.  Where the income of the trust consists of or includes profits and gains of business, income tax shall be charged in the hands of trustee(s) on the whole of the income at the maximum marginal rate. This provision is not applicable, in the case of a trust which has been declared by any person exclusively for the benefit of any relative dependent on him and also such trust is the only trust so declared by him. When the individual shares of the beneficiaries are indeterminate or unknown [under section 164]:-  Trustee(s) is liable to tax as a representative assesses.  Where the income consists of, or includes, profits and gains of business, the entire income of the trust is charged at the maximum marginal rate of tax, except in cases of the a trust which has been declared by any person exclusively for the benefit of any relative dependent on him and also such trust is the only trust so declared by him.  Where the income does not consist or include profits and gains of business, income is chargeable at the maximum marginal tax rate. However, the maximum marginal rate of tax is not applicable in the following cases, and the income will be chargeable to tax as if it were income of an association of persons(AOP):- a) Where none of the beneficiaries has any other income chargeable to tax under the Income Tax Act and none of the beneficiaries is a beneficiary under any other trust or b) Where the relevant income or part of 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 c) Where the trust is a non-testamentary trust created before March 1, 1970 for the exclusive benefit of relatives of the settlor mainly dependent on him for their supporter maintenance or, where settlor is a Hindu undivided family, for the exclusive benefit of its members so dependent upon it or d) Where the trust is created on behalf of a provident fund, superannuation fund, gratuity fund, pension fund or any other fund created bona fide by a person carrying on a business or profession exclusively for the benefit of persons employed in such business or profession. In cases of (a), (b) and (c) supra, the relevant income is taxable in the hands of trustees as if it were the total income of an association of persons, while income falling under (d) supra is exempt from tax. 540

As a general rule such trusts are taxed at the maximum marginal rate (MMR). This rule is however subject to certain exceptions (for the exact manner of taxability of discretionary trust, see table). 5.2.4. Different Types of a Family Trust A person competent to contract, may form any of the following types of Trust: 1) Bare Trust: A trust where the beneficiary is absolutely entitled to the assets and the trustee is obliged simply to pay them over to the beneficiary. 2) Constructive Trust: It is imposed by law as an equitable remedy. It generally occurs due to some wrong doing. 3) Resulting Trust: It is a form of implied trust which occurs where a trust fails, wholly or in part, as a result of which the settlor becomes entitled to the assets. 4) Discretionary Trust: It is an arrangement where the trustee may choose, from time to time, who (if anyone) among the beneficiaries is to benefit from the trust, and to what extent. Such trusts are essentially used for asset protection. 5) Fixed Trust: The entitlement of the beneficiaries is fixed by the settlor. The trustee has little or no discretion. Such trusts are used by families which have members with disability in their family. 6) Hybrid Trust: It combines elements of both fixed and discretionary trusts. The trustee must pay a certain amount of the trust property to each beneficiary fixed by the settlor. But the trustee has the discretion as to how any remaining trust property, once these fixed amounts have been paid out, is to be paid to the beneficiaries. 541

7) Express Trust: It arises where a settlor deliberately and consciously decides to create a trust, over his or her assets, either now or upon his death. 8) Implied Trust: It is created where some of the legal requirements for an express trust are not met, but an intention on behalf of the parties to create a trust can be presumed to exist 5.2.5. Family Trust V/s Will One main difference between a will and a trust is that a will goes into effect only after you die, while a trust takes effect as soon as you create it. A will is a document that directs who will receive your property at your death and it appoints a legal representative to carry out your wishes. By contrast, a trust can be used to begin distributing property before death, at death or afterwards. A trust is a legal arrangement through which one person (or an institution, such as a bank or law firm), called a \"trustee,\" holds legal title to property for another person, called a \"beneficiary.\" A trust usually has two types of beneficiaries -- one set that receives income from the trust during their lives and another set that receives whatever is left over after the first set of beneficiaries dies. A will covers any property that is only in your name when you die. It does not cover property held in joint tenancy or in a trust. A trust, on the other hand, covers only property that has been transferred to the trust. In order for property to be included in a trust, it must be put in the name of the trust. Another difference between a will and a trust is that a will passes through probate. That means a court oversees the administration of the will and ensures the will is valid and the property gets distributed the way the deceased wanted. A trust passes outside of probate, so a court does not need to oversee the process, which can save time and money. Unlike a will, which becomes part of the public record, a trust can remain private. Wills and trusts each have their advantages and disadvantages. For example, a will allows you to name a guardian for children and to specify funeral arrangements, while a trust does not. On the other hand, a trust can be used to plan for disability or to provide savings on taxes. Difference between a Will and a Trust Trust Beneficiary need not go to any Will court for getting access to the  If you create a will, the beneficiary  property. may need to obtain probate from It applies to the assets held by the the court. trust only.  It applies to all the assets of the  Trust can be executed during the deceased.  It is executed only after the death of  542

the testator. lifetime of the settlor and continues even after his death.  It becomes public document when  It is a confidential document. filed in the court for obtaining a probate.  No control over the wealth after  Enables milestone-driven being distributed. distribution of wealth.  Bequests are subject to third-party  Subject to certain conditions; offers claims and attachments. protection to the estate from extended families such as daughter-in-law or business liabilities. 5.2.6. Parties to Trust A trust is created when one party with property, the settlor, transfers that property to another party, the trustee, for the benefit of a third party, the beneficiary or beneficiaries. In principle this means there are at least three essential parties to a trust: the settlor, the trustee and the beneficiary/ies.  Author/Settlor/Trustor/Grantor: The person who creates the trust agreement. The person who reposes or declares the confidence is called the\" author of the trust―.  Trustee: The person who holds the property for another's benefit. The person who accepts the confidence is called the\" trustee―.It is important to note, however, that the settlor is not officially a party to the trust, because he no longer has a legal interest in the trust property. Nonetheless, no trust could exist without a settlor, as the settlor is the party who transfers assets to the trust to begin with.  Trusts also allow for a protector, which is a party who oversees the trustee´s administration of trust assets, and whose permission is required before the trustee can take certain actions  Beneficiary: The person who is benefited by the trust. The person for whose benefit the confidence is accepted is called the\" beneficiary―. It is important to note, however, that the settlor is not officially a party to the trust, because he no longer has a legal interest in the trust property. Nonetheless, no trust could exist without a settlor, as the settlor is the party who transfers assets to the trust to begin with. Trusts also allow for a protector, which is a party who oversees the trustee´s administration of trust assets, and whose permission is required before the trustee can take certain actions 543

Protector/ Administrator of the Trust While appointing a Corporate Trustee a person creating a Trust may also appoint certain family persons as Administrators/ Protectors of the Trust settled by them to retain control indirectly over the Trust. By appointing Administrators/ Protectors the person creating the Trust can ensure that the activities of the Trust are conducted by the Trustee under the supervision and guidance of the Administrator/ Protector and as instructed by the person creating the Trust in the Trust deed. 5.2.7. Hybrid Trusts Hybrid Trust: It combines elements of both fixed and discretionary trusts. The trustee must pay a certain amount of the trust property to each beneficiary fixed by the settlor. But the trustee has the discretion as to how any remaining trust property, once these fixed amounts have been paid out, is to be paid to the beneficiaries. Indian trust law does not lay down restrictions with respect to a trust being set up with hybrid characteristics i.e. having both, determinate and discretionary features for different classes of assets in the same trust or provide a specific format for the trust instrument. This flexibility allows a trust structure to be devised to suit the specific needs and requirements of the settlor and eliminates the need to create multiple trusts. 544

5.2.8. Cancellation (Extinguishing) and Revocation of Trust A Trust is Extinguished- a) when its purpose is completely fulfilled; or b) when its purpose becomes unlawful; or c) when the fulfillment of its purpose becomes impossible by destruction of the trust- property or otherwise; or d) when the trust, being revocable, is expressly revoked. Revocation of Trust A trust created by Will may be revoked at the pleasure of the testator. A trust otherwise created can be revoked only- a) by consent of all the Beneficiaries (competent to contract); b) where the trust has been declared by a non-testamentary instrument or by word of mouth- in exercise of a power of revocation expressly reserved to the author of the trust; or c) where the trust is for the payment of the debts of the author of the trust, and has not been communicated to the creditors at the pleasure of the author of the trust. Illustration: A conveys property to B in trust to sell the same and pay out of the proceeds the claims of A's creditors. A reserves no power of revocation. If no communication has been made to the creditors, A may revoke the trust. But if the creditors are parties to the arrangement, the trust cannot be revoked without their consent. Revocation not to defeat what trustees have duly done No trust can be revoked by the author of the trust so as to defeat or prejudice what the trustees may have duly done in execution of the trust. 5.2.9. Other Provisions Registration of Trusts A private trust which has movable property only does not need to be registered. However, a private trust with immovable property needs to be registered under the Registration Act, 1908. Information on private trusts is not publicly available, unless such trusts have been registered. All public trusts, irrespective of which state they are settled in, have to be registered under the Registration Act, 1908. However, there is a state-specific legislation for public trusts in certain states in India. In such a case, the public trusts have to register under the statespecifi c legislation as well as the Indian Registration Act, 1908 in that order. For example, a public state 545

registered in states of Gujarat and Maharashtra needs to be registered under the Bombay Public Trusts Act, 1950. Under this Act, a public trust must apply for registration within three months from the date of creation.  Registration under the Registration Act, 1908: the trustee of every public trust is required to send a memorandum in the prescribed form containing the particulars, including the name and description of the public trust and the immovable property of such a public trust, to the Sub-Registrar of the sub-district appointed under the Registration Act, 1908, in which such immovable property is situated for the purpose of fi ling in Book No. I as prescribed under section 89 of the Registration Act, 1908.  The Bombay Public Trusts Act, 1950 (registration requirements for a charitable trust): the following documents are required to be fi led in order to register a charitable trust with the charity commissioner‘s offi ce: - a covering letter; - an application form in Form–Schedule II under rule 6 duly notarized; - a court fee stamp of ₹2/- to be affixed on the application form; - a certified copy of the trust document; - a consent letter of trustees.  Registration under the Income Tax Act, 1961: charitable or religious trusts, societies, and companies claiming exemption under sections 11 and 12 of the Income Tax Act, 1961 are required to obtain registration under this Act. Private/family trusts are neither allowed such exemption nor required to seek registration under the Income Tax Act. The detailed registration procedure is set out in section 12AA of the Income Tax Act.  Registration under the Foreign Contribution (Regulation) Act, 1976 (‗the FCRA‘): any charitable trust desirous of receiving foreign contributions from foreign sources is required to obtain registration under section 6(1) of the FCRA. Any such trust which is not registered or which has been denied registration, can receive foreign contributions only after obtaining prior permission from the home ministry of the central government under section 6(1A) of the FCRA. In order to obtain registration under the FCRA, the applicant association should preferably be incorporated as a legal entity, ie as a charitable trust and should have been working for a period of at least three years. The association must not have received any foreign contributions previously without prior permission of the government. All the trusts have to apply for a permanent account number, which enables the trustees to pay tax on behalf of the benefi ciaries at the trust level itself. 546

SUMMARY  Succession of family-owned assets and interests in a business can be effected through various modes depending on the goals to be achieved and the challenges thrown due to sensitive family dynamics. If desirous of completing the transfer during one's lifetime, outright sale, making a gift and setting up a trust are some popular modes employed. On the other hand is the more traditional mode of bequeathing one's assets under a Will, where the transfer takes effect upon the testator's demise.  The term co-owner is wide enough to include all forms of ownership such as joint tenancy, tenancy-in - common, coparcenary, membership of Hindu Undivided Family  An offshore trust is simply a conventional trust that is formed under the laws of an offshore jurisdiction.  India has a creditor protection period of two years, on completion of which the assets transferred irrevocably to the trust cannot be attached in case of any proceedings against the settlor.  The Indian Trusts Act, 1882 defines a trust as being a legal obligation annexed to the ownership of property and arising out of a confidence reposed in the trustee by the settlor, for the benefit of the beneficiaries as identified by the settlor including / excluding the settlor himself.  The person who reposes or declares the confidence is called the ―author of the trust‖; the person who accepts the confidence is called the ―trustee‖. The person for whose benefit the confidence is accepted is called the ―beneficiary‖ and the subject matter of the trust is called ―trust property‖; the ―beneficial interest‖ or ―interest‖ of the beneficiary is the right against the trustee as owner of the trust property; and the instrument, if any, by which the trust is declared is called the ―instrument of trust‖.  A revocable trust is one that the settlor can terminate at his option. On termination, legal title to the trust assets returns to the settlor. By contrast, an irrevocable trust is permanent, and the settlor may not revoke or modify its terms.  A simple trust is one that doesn‘t make charitable contributions or allow for any distributions other than those that come from income earned, which must be distributed to beneficiaries in the tax year that it is earned. A complex trust can make charitable contributions and is not required to pay out all income in the year that it is earned by the trust. In a complex trust, the principal value of an asset may also be paid out.  A Private Trust can be further divided into specific trusts (determinate trust or non- discretionary trusts) and Discretionary Trusts (Indeterminate Trusts). A discretionary trust is a trust in which the individual shares in income or corpus of the beneficiaries are indeterminate or unknown. Determinate Trust: The entitlement of the beneficiaries is fixed by the settlor, the trustees having little or no discretion. 547

 A trust is extinguished- (a) when its purpose is completely fulfilled; or (b) when its purpose becomes unlawful; or (c) when the fulfillment of its purpose becomes impossible by destruction of the trust-property or otherwise; or (d) when the trust, being revocable, is expressly revoked. A trust created by Will may be revoked at the pleasure of the testator.  A private trust which has movable property only does not need to be registered. However, a private trust with immovable property needs to be registered under the Registration Act, 1908. 548

SELF-ASSESSMENT QUESTIONS 1. Which regulatory authority has the power to approve settlement or transfer of assets created abroad in case of an offshore trust? (a) Securities and Exchange Board of India (b) Ministry of External Affairs (c) Income Tax Authority (d) Reserve Bank of India 2. A person who creates the trust is known as ________. (a) Executor (b) Testator (c) Trustee (d) Settlor 3. The following is not an obvious advantage of creating a private trust over a will? (a) Execution (b) Confidentiality (c) Costs (d) Amendment 4. Which of the following with regards to trust would not be taxed at the maximum marginal rate? (a) The trust is discretionary and has income from capital gains (b) The trust is indeterminate, declared by the last will of the testator and has income from business (c) The trust is determinate and has income other than from business or profession (d) The trust is established is an oral trust 5. A trust is created by a son, the Settlor, for the survival expenses of his retired parents each having equal beneficial interest. Both husband and wife have separate fixed pension of ₹35,000 per month and ₹30,000 per month, respectively. The trust property has generated a net annual value of ₹5.12 lakh in the previous year 2017- 18. The trustee as well as the Settlor is in the 30% tax bracket. Find the tax payable by the trustee as representative assessee. (a) Rs. 79,100 (b) Rs. 46,760 (c) Rs. 1,01,350 (d) Rs. 71,480 549

6. Which of the followings are the forms of co-ownership? (a) Joint tenancy (b) Tenancy-in-common (c) Coparcenary (d) Hindu Undivided Family A. (i) and (ii) B. (iii) and (iv) C. (i), (iii) and (iv) D. (i), (ii), (iii) and (iv) 7. In the case of a rented property a covenant ( a contract, a mutual agreement) can be imposed by (i) tenant (ii) Landlord (a) By tenant (b) By Landlord (c) Both by tenant and landlord (d) Neither by tenant or nor by landlord 8. Which of the following form of co-ownership must be created by an instrument of deed or will? (a) Joint Tenancy (b) Tenancy in common (c) Coparcenary (d) HUF 9. Which of the following is not an essential element of a trust: (a) Trustee (b) Personal obligation (c) Beneficiary (d) Administrator 10. When can a trust created by a will be revoked? (a) A trust once created cannot be revoked (b) It can be revoked at the pleasure of the testator during his lifetime (c) It can be revoked only after its purpose is fulfilled (d) It can be revoked only with the permission of Court, 550

ANSWERS 1. (D) Reserve Bank of India 2. (d) Settlor 3. (C) Costs 4. (C) The trust is determinate and has income other than from business or profession 5. Pension (Inc. from Salary) of the male beneficiary: ₹420,000 p.a. (35000*12) Pension (Inc. from Salary) of the female beneficiary: ₹360,000 p.a. (30000*12) Net Annual Value from trust property in FY2017-18: ₹512,000 Assessable taxable income of male beneficiary: ₹676,000 (420000+512000/2) Assessable taxable income of female beneficiary: ₹616,000 ₹360000+512000/2 Tax on the income from trust of male beneficiary: 39,200 ₹(676000-500000)*20%+(500000- 420000)*5% Tax on the income from trust of female beneficiary: 30,200 ₹(616000-500000)*20%+(500000- 360000)*5% Total tax assessable on trust income 39,200 + ₹30200 = 69400 (Tax + Cess) payable by trustee as representative assessee 71482 Answer = ₹71,480 (rounded off) 6. (D) (i), (ii), (iii) and (iv) 7. (C) Both by tenant and landlord 8. (A) Joint Tenancy 9. (A) Administrator 10. (B) It can be revoked at the pleasure of the testator during his lifetime 551