India: Estate Planning Through Trusts

Last Updated: 22 October 2015
Article by Sachin Vasudeva

The concept of trusts goes back to the 1880s and in today's age and time trust structures are becoming increasingly important when individuals seek to plan their estate. While the prime objective of trust formation remains ring fencing of the assets, trusts structures are commonly being used in the following situations:

  • Pursuing Philanthropy
  • Maintaining inter-generational family control on business
  • Provision for foster children or children with special needs
  • Benefit of minor children, in the event of accidental death of both parents
  • Marital discord

Under the Indian Trust Act of 1882, trust is defined as 'an obligation annexed to the ownership of property, and arising out of a confidence reposed in or accepted by the owner, or declared and accepted by him, for the benefit of another, or of another and the owner'.

The parties to the Trust are:

  • Author/Settlor: person who declares the trust
  • Trustee: person who accepts the confidence
  • Beneficiary: the person for whose benefit the confidence is accepted

It is impermissible for an individual to hold all the three roles since no trust can exist where the entire property is vested in one person. As would be evident the trustee has a very important role to play in the operation of the trust and therefore many a time's institutional trustees are also appointed. It is also common for the settlor to appoint a 'protector' or an 'advisor' to the trust. The role of these people is to oversee the decisions taken by the trustee so that the wishes of the settlor are duly followed.

Section 2(31) of the Income-tax Act, 1961 (the Act) defines a 'person' but does not expressly include a 'trust' as a 'person'. Therefore the trustees are taxed as representative assessees under section 160 of the Act. The type of trust is a key determinant that influences the taxation of the trust. A trust can be classified as a determinate trust (where shares of beneficiaries are defined) or a discretionary trust (where shares of beneficiaries are not defined but is based on trustee's sole discretion). A trust can be revocable or irrevocable.

The types or categories of trusts in India and the applicable rules to tax such trusts have been highlighted below.

Revocable vs. Irrevocable Trusts: An important categorisation that determines how a trust shall be taxed under the provisions of the IT Act is whether the trust is revocable or irrevocable. This distinction is based on whether the settler or creator of the trust retains the power to control the assets so as to benefit by transferring back the assets or income thereof to himself.

Section 63 of the IT Act states that a transfer is deemed to be revocable if (i) It contains any provisions for transfer (directly or indirectly) of the whole or any part of the income or assets to the transferor, or (ii)(b) It gives the transferor a right to re-assume power (directly or indirectly) over the whole or part of the income or assets.

The determination of whether a trust is revocable or not, is important from an Indian tax perspective mainly because under the IT Act, all income arising by virtue of a revocable transfer of assets is chargeable to tax as income of the transferor and included in his total income. Any transfer of an asset to a trust is not treated as a revocable transfer if the trust is not revocable during the lifetime of the beneficiaries. However, where the transferor derives any direct or indirect benefit from the income arising from the transferred assets, it would be regarded as a revocable transfer, as a consequence of which income would be taxable as the income of the transferor.

Determinate vs. Discretionary Trusts: The following rules as specified in the Act apply to determinate and discretionary trusts:

Having understood the types of trusts and its assessment it is important to understand the provisions which are applicable for applicable taxable events.

Capital Gains Tax Implications

Under Section 47(iii) of the Act, any transfer of a capital asset under a gift or will or an irrevocable trust is exempt from any capital gains taxation. Further, when the property is transferred to an irrevocable trust, no gains are made by the author of the trust who transfers the property and therefore the question of levying capital gains tax which can only be on the gains realised by the transferor does not arise at all. It should be noted that there is no exemption from payment of Stamp Duty.

Implications under Section 56(2)(vii) of the Act

Section 56(2)(vii) of the Act provides that for the taxation of any sum of money and specified properties (value of which exceeds fifty thousand rupees) received by an individual or a Hindu Undivided Family ("HUF") without consideration or for inadequate consideration as 'income from other sources'. The question therefore arises whether there is any tax implication at the time of settlement of the trust or at the time of distribution of income from the trust.

The answer to both the questions should be 'No' as the purpose or legislative intention of creating a trust is defeated if a tax liability is incurred at the time of settlement. Further, the trustee does not receive property or assets for their benefit.

They receive the property in their capacity as 'trustees'. It can also be argued that this is not a case of 'inadequate consideration for without consideration'. An amount which is otherwise not taxable under section 56(2)(vii) of the Act cannot be made taxable because it is routed through a trust structure.

Conclusion

A trust structure can be effectively used for asset protection and distribution. It also enables the distribution of assets as per the wishes of the settlor and can the objective can be achieved during the lifetime of the settlor as opposed to a WILL which comes into operation only after passing of the Testator.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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