India: Determinacy Of A Trust – Indian Tax Insights

Last Updated: 22 March 2017
Article by Abhay Sharma and Oscar Dsa

Trust structures have gained popularity over the years in India as vehicles for pooling of investments and for estate planning by high net-worth individuals. With respect to investment funds, a tax pass-through mechanism is vital as the investors would prefer that the income is taxed at the investor level as opposed to being taxed in the hands of the trust. A tax pass through for trusts is fairly common in several jurisdictions. The tax code in India too provides for a tax pass-through for certain types of funds such as Category I & II Alternative Investment Funds ("AIFs"), Securitisation Trusts and a partial tax pass through for Real Estate Investment Funds ("REITs") and Infrastructure Investment Trusts ("InvITs").

However, the taxability of other types of trusts in India remains a complex issue due to a myriad of factors, primary among them being the nature of the trust itself. The nature of trusts, whether determinate or indeterminate, plays an important role in governing its taxability. As per the taxation law, trusts are considered to be determinate if the individual shares of the beneficiaries are expressly stated in the trust deed and are identifiable and ascertainable as on the date of the trust deed. In case of a determinate trust, tax is charged in the hands of the trustees in the capacity of a representative assessee qua each beneficiary, whereas in case of an indeterminate trust, the trust is treated as an 'association of persons' and tax is charged on the entire income of the trust at the maximum marginal rate ("MMR").

AIFs formed under SEBI regulations are often set up in the form of a trust instead of a partnership or a limited liability partnership due to the relative simplicity in their formation and administration. The Finance Act 2015 granted a complete pass through to Category I AIFs and Category II AIFs hitherto enjoyed only by a select category of Venture Capital Funds ("VCFs"). A tax pass-through of sorts was generally achieved for other non-exempt VCFs or funds through inter alia the formation of a determinate trust. Hence, it is important to understand when a trust is considered to be a determinate trust. There has been a fair amount of litigation around whether the beneficiaries of a trust should be identifiable and should exist at the time of creation / settlement of the trust, for a trust to be treated as determinate trust and taxed accordingly. Recently, the Karnataka High Court in the case CIT v. India Advantage Fund-VII1 had the opportunity to deal with this issue.

The Karnataka High Court upheld the ruling of the Bangalore Tribunal wherein it held that where as per the trust deed the benefits are to be shared by the beneficiaries in proportion to the investment made, it could be concluded that the shares are determinable and the income of trust should be taxed in the hands of the beneficiaries and not the trustees. Further, the Court laid down the following principles to come to the conclusion:

  • It is not the requirement of law that trust deed should actually prescribe the percentage share of the beneficiary in order for the trust to be determinate. It would be sufficient if the shares are capable of being determined based on the provisions of the trust deed.
  • It would not make any difference even if the trust deed authorises addition of further contributors to the trust at different points of time, in addition to initial contributors, than the same would not make the beneficiaries unknown or their share indeterminate.

The ruling is especially relevant given a circular previously issued by the Central Board of Direct Taxes ("CBDT") which was ostensibly aimed at clarifying issues with regard to taxation of AIFs being non-charitable trusts where the investors name and beneficial interest are not explicitly known on the date of its creation ("Circular"). The Circular states that if the trust deed either does not name the beneficiaries or does not specify their beneficial interest then the trust would be considered as indeterminate trust and the trustees in the capacity of the representative assessee would be liable to pay tax at the MMR. The Circular further stated that the clarifications would not apply in a state wherein the jurisdictional High Court had adopted a contrary view. Interestingly, this Circular is not discussed or referred in the Karnataka High Court ruling.

The Karnataka High Court ruling provides some clarity on determination of the nature of the investment trust and should provide a modicum of relief to the fund industry.

Though, the tax law has been amended over the years and now provides for a tax pass through to certain types of fund, going forward the Karnataka High Court ruling would provide some relief for determination of tax pass-through status of other funds such as Category III AIF. Further, in case of private client structures a determinate trust structure can be achieved, if required, by defining appropriately the beneficiary and their beneficial interest.


1. (2017) 78 301 (Karnataka)

The views expressed in this article are strictly individual views and not that of the firm. 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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