The Income Tax Appellate Tribunal (the Tribunal) "B" Bench, Bangalore has been making headlines across the country of late for its pro-assessee ruling in the decision in The Deputy Commissioner of Income Tax, Circle 9(1), Bangalore vs. M/s India Advantage Fund pronounced on October 17, 2014. The Tribunal has added much strength to Trusts under the Indian Trusts Act, 1882 doubling up as investment vehicles by ruling that the assessment of income tax vis-ŕ-vis the pooling of funds into a revocable trust would be in the hands of the beneficiaries and not against the trustee in the capacity of a representative assessee.
The appeal before the Tribunal was with respect to the assessment of India Advantage Fund (the Trust/ Assessee Trust), setup as a trust under the provisions of the Indian Trusts Act, 1882 through the execution of a trust deed, with ICICI Venture Funds Management Company Limited (Settlor/ Investment Manager) acting as the Settlor and The Western India Trustee and Executor Company Limited as the Trustee. The objective of creation of the trust was to facilitate investment in certain securities called mezzanine instruments and to achieve commensurate returns to the contributors or beneficiaries. The fund collected from the contributors together with the initial corpus was to be handed over to the trustee.
Though the saga is yet to come to a close (since an appeal before the High Court and then on to the apex court still lies), Tribunal's rejection of the appeal has been welcomed by all factions of the business world. The judgment has brought much needed clarification of the repercussions of the CBDT Circular No. 13/2014 (the Circular) according to which all Alternate Investment Funds subject to the SEBI (Alternate Investment Funds) Regulations, 2012 and which are not venture capital funds and non-charitable trusts, where the names and the beneficial interest of the investors is not mentioned are to be treated to be taxed at the marginal rate of tax in the hands. The Tribunal has also discussed key concepts such as discretionary and determinate trusts, Association of Persons (AOP), revocable trusts, and the interpretation of the relevant provisions of the Income Tax Act, 1961 (the Act).
The Revenue's case for assessment
Following the decision of the Assessing Officer (AO) that the entire income of the Trust should be taxed in the hands of the representative Trustee itself as per the provisions of Section 164 (1) of the Act, the Trust preferred an appeal before the Commissioner of Income Tax – Appeals (CIT(A)) where the decision was reversed and the NIL returns filed by the Trust were deemed fit and proper and held that no income was taxable in the trustee's hands. Accordingly, the Revenue preferred an appeal before the Tribunal inter alia on the following grounds:
- The CIT(A) has erred in holding the Trust to be a revocable trust and accordingly not liable to be taxed since the tax obligations have been fully discharged by the beneficiaries;
- The names of the beneficiaries are not identifiable in the trust deed;
- The shares of the beneficiaries are not mentioned in, and not determinable on the basis of the trust deed;
- The distribution of shares is not as per the formula set out in the trust deed; and
- The CIT(A) erred in holding the Trust not to be an AOP;
The Tribunal's rationale
The nature of the Trust, i.e. whether it is discretionary or non-discretionary would play a crucial role in deciding whether the income of the Trust would be taxed in the hands of the representative trustee or in the hands of the beneficiaries. The Tribunal noted that the concept of representative assessment vide the introduction of Section 164 of the Act was to curb unscrupulous tax avoidance. Essentially, the position that the law intended to prevent was the treatment of a trust as determinate at the time of assessment, while in truth its distribution of income was very much discretionary.
The Tribunal observed that the Assessee Trust had submitted before the AO and the CIT(A) that the assessment of the funds is to be made in the hands of the beneficiaries in light of Section 164 of the Act since the Trust would qualify as a revocable trust in accordance with the provisions of Sections 61, 62 and 63 of the Act. On an analysis of the provisions of the trust deed and other related agreements such as the private placement memorandum and the agreement entered into by the Trust with each beneficiary, the Tribunal held that that the Trust is very much determinate in nature.
The Tribunal clarified that the law does not ordain that the individual names of each beneficiary should be specified in the trust deed and that the definition of a beneficiary in Clause 1.1.13 of the trust deed would suffice to identify the beneficiaries. With respect to the argument of the Revenue regarding the ascertainment of share of the beneficiaries, the Tribunal held that Clause 6.5 of the trust deed clearly specifies the manner in which the income of the Assessee Trust is to be distributed; the Tribunal added further that as rightly contended by the Assessee Trust, the requirement of the law is not for the trust deed to specify the percentage share of the beneficiary for the trust to be determinate.
Accordingly, for such reasons, the Tribunal held that the Trust would fall squarely within the understanding of a revocable trust as under Section 61 read with Section 63 of the Act.
Determinate trust not AOP:
In support of its submission that the Trust is to be regarded an AOP, the Revenue contended that there is no separate status of a Trust for purpose of assessment envisaged under the Act, and that the definition of person under Section 2(31) of the Act which deals with the definition of a person does not specifically refer to a "Trust".
The Tribunal, after considering the evolution of the definition of a person since the Income Tax Act of 1922, held that the definition of "person" under Section 2(31) of the Act includes Association of Persons. The Tribunal then proceeded with a threadbare analysis of the relevant provisions of the trust deed and concluded that the beneficiaries contributed their monies to the Assesee Trust, and a separate agreement was entered into between the Assessee Trust and each beneficiary. There is no inter se arrangement between one beneficiary and another as each of them entered into separate contribution arrangement with the Assessee Trust.
The Tribunal observed further, that the beneficiaries have not setup the Trust and therefore it cannot be said that the beneficiaries have come together with the object of carrying on investment in mezzanine funds, which is the object of the trust. The beneficiaries are mere recipients of the income earned by the trust. Accordingly, in this manner, the Tribunal dismissed the Revenue's argument that the Trust is an AOP.M
No retrospective effect of the Circular
Besides qualifying with elaborate reasoning that the Trust in the present case is very much revocable and determinate, and accordingly not of the sort contemplated by the Circular, the Tribunal also considered the applicability of the Circular itself. The Circular, dated July 28, 2014, was held not applicable for the reason that it was not in force at the relevant Assessment Year when the assessment of the Trust was made by the AO. Relying upon the decision of the Hon'ble Bombay High Court in BASF (India) Ltd. & Anr. vs. W. Hasan, CIT & Ors. 280 ITR 136 (Bom), the Tribunal concurred that Circulars not in force in the relevant Assessment Year cannot be relied upon and given effect to.
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