India: No "Pass Through" Status For Indeterminate Trusts Holds Tribunal

The Chennai Bench of the Income-tax Appellate Tribunal (Tribunal) in its recent ruling in TVS Investments iFund v ITO ([2017] 81 296), while succinctly discussing the conditions that are required to be satisfied for a trust to be accorded "pass through" status in terms of Sections 161 and 164 of the (Indian) Income-tax Act, 1961 (IT Act), has held that no such status can be accorded to indeterminate trusts, subject to certain exceptions.


TVS Investments iFund (Fund) was formed to receive unit contributions from high net worth individuals (HNIs) towards the capital amount committed by them in terms of the 'Contribution Agreement' and provide return on such investments. To this end, the Fund was able to mobilize over INR 400 million from 656 HNIs. In due course, another fund by the name of TVS Shriram Growth Fund (TSGF) was formed and was registered with the Securities and Exchange Board of India (SEBI) under the SEBI (Venture Capital Funds) Regulations, 1996.

Pursuant to TSGF being registered as a venture capital fund (VCF) with the SEBI, commitments from the Fund were sought to be transferred to TSGF for the purpose of better synergy and higher returns. With the exception of 17 investors, all others consented to rollover their respective commitments to TSGF. Accordingly, out of the total amount collected, contributions from the 639 consenting contributors were transferred by the Fund to TSGF in 6 tranches spread over approximately 6 months.

Out of its earnings from bank deposits, the Fund credited the proportionate value of earnings corresponding to the 17 retained investors to its profit and loss account, treating it as its income, which in turn was further reduced to nil. Contrary to this, the Assessing Officer sought to tax the entire interest income in the hands of the Fund, which order was confirmed by the first appellate authority. The Fund, in its capacity as 'representative assessee', claimed that since the income had been transferred to TSGF, the entire interest income of the 639 beneficiaries ought not to be taxed in its hands.

Tribunal's Ruling

  • Only the income of VCFs is tax exempt under Section 10(23FB) of the IT Act. There is no such specific exemption for other Alternate Investment Funds (AIFs). Therefore, taxation of such other funds (eg. the Fund in the instant case) depends on the legal status of the fund, i.e. whether a particular fund has been set up as a company, limited liability partnership, or a trust.
  • Since the Fund was set up as a trust, it was to be taxed along the principles of taxation of trusts in terms of Sections 161 and 164 of the IT Act. For a trust to be taxed under these provisions, there are certain tests to be satisfied, viz. the trust must be an irrevocable, determinate and non-discretionary trust.
  • A trust is accorded 'pass through' status (which essentially means that any income received by a beneficiary / contributor out of investments made by the trust shall be chargeable to tax in the same manner as if such investments had been made directly by the beneficiary / contributor) under Section 164 of the IT Act if it fulfills the following two conditions of determinacy –

    • Names of the beneficiaries are specified in the trust deed; and
    • The respective shares of the beneficiaries are ascertainable on the date of the trust deed.
  • Therefore, for a trust to qualify as a specific / determinate trust, it is essential that the trust deed itself specify the category of the beneficiaries and prescribe the method for determining the share of each beneficiary.
  • If a trust fails to satisfy the test of determinacy as set out above, then in terms of Section 164(1) of the IT Act, the income of trust is chargeable to tax at the maximum marginal rate (i.e. at the rate of 30% plus applicable surcharge and education cess), subject to certain prescribed exceptions. However, if the trust satisfies the test, then the trust will be treated as a "pass through" conduit. In such a case, the revenue authorities have the option to tax the income either in the hands of the beneficiary, or in the hands of the trustee, in its capacity as representative assessee.
  • The exception to this rule, i.e. when "pass through" status is extended even to an indeterminate trust, is only applicable to VCFs which are registered with the SEBI and are eligible for the exemption under Section 10(23FB) read with Section 115U of the IT Act.
  • In the instant case, however, neither were the names of the beneficiaries incorporated in the trust deed, nor were the individual shares of the beneficiaries ascertainable on the date of institution of the Fund. The investment manager of the Fund merely gathered monies from the contributors and the benefit therefrom passed on to the contributors based on the proportion of their investments in the Fund. Since on the date of institution of the trust deed, the identities of the contributors / beneficiaries were not known, the Fund could not be categorized as a determinate trust so as to gain "pass through" status.
  • Further, since the Fund was not a SEBI registered VCF, it was not eligible to avail of the "pass through" benefit under Section 10(23FB) of the IT Act. If every trust were to ipso facto become eligible for "pass through" status, then specific exemptions in the form of Section 10(23FB) read with Section 115U of the IT Act would be rendered nugatory. Therefore, a trust cannot enjoy "pass through" status unless it is a determinate trust or is a SEBI registered VCF in terms of Section 10(23FB) of the IT Act.
  • Since the interest income from the fixed deposits was earned while the Fund held the monies in its own name and the transfer of beneficiaries / income to TSGF took place subsequent to the interest earning period, the income passed on to TSGF could not be said to be TSGF's income, but was merely application of the Fund's own income. Hence, the interest income attributable to the 639 transferred beneficiaries was also liable to be taxed in the hands of the Fund and not merely the proportionate income relating to the 17 retained contributors.


The ruling emphasizes that the taxation of funds is primarily based on the nature of the trust, which in turn is determined by the construction of the instrument of the trust. The Tribunal unequivocally sets out the most important ingredients for a trust to enjoy "pass-through" status – irrevocability and determinacy (i.e. beneficiaries should be known and the individual share of those beneficiaries should be ascertainable as on date of the trust deed). This reasoning of the Tribunal stands in direct conflict with the principles laid down by the Karnataka High Court in the case of CIT v India Advantage Fund-VII ([2017] 78 taxmann.com301), which decision was not considered in the instant case. In India Advantage Fund-VII, the Court rightly held that determinability of the shares of the beneficiaries of a trust does not necessarily depend on a fixed quantum / percentage set out in the trust deed on the date of its execution. The real test is whether the shares are capable of being determined in terms of the provisions of the trust deed, whether at the time of or after the formation of the trust. Once the shares are determinable amongst the beneficiaries, the trust would meet the requirement of the law to come out from the applicability of Section 164 of the IT Act.

Given the nascency of the funds industry in India and the lack of judicial guidance on the taxability of funds (especially trusts, other than SEBI registered VCFs), instead of bringing greater clarity on a subject that has largely remained judicially untested, this ruling further exacerbates the uncertainty in relation to taxation of a fund, especially where the names of the beneficiaries are not specifically mentioned in the trust deed on the date of its execution.

Since the trust deed is the binding document to identify whether the conditions for determinacy have been satisfied or not, trust instruments ought to be carefully drafted. Further, to mitigate against potential litigation and the associated liability risk for the trustee / investment manager, fund documents should provide for taxation at the fund level.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at

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