1. INTRODUCTION
1.1 India is witnessing a surge in the number of ultra-high-net-worth individuals (Ultra HNIs) over the past few years. In 2022, India overtook UK to claim its place as the world's fifth largest economy with wealth creation being a natural by-product of this growth.1
1.2 Creation of a family trust is one of the most effective modes for such planning. Trust is a legal arrangement wherein one party entrusts his property to another for the benefit of a third person. Typically, a trust involves three key participants: the settlor (who establishes the trust), the trustee (who is entrusted with managing the trust), and the beneficiary (for whose benefit the trust is established).2
1.3 A trust may be either a revocable trust or an irrevocable trust. A revocable trust is one where the settlor retains the right to modify, amend, or revoke the trust at any time during their lifetime. An irrevocable trust is one where the settlor relinquishes all control over the trust once it is created. The terms of the trust cannot be modified or revoked without the consent of the beneficiaries and the trustee.
1.4 Private trusts may be specific or discretionary. In case of a specific trust, the shares of the beneficiaries are known. However, in case of a discretionary trust, the shares of the beneficiaries are not known, and the distribution is left to the discretion of the trustee.
1.5 Trustee(s) of a trust are treated as "representative assessee" in respect of income received or receivable (by the trust) on behalf of the beneficiaries of the trust.3 The tax implications primarily depend upon the type of the trust (specific / discretionary and revocable / irrevocable).
1.6 With multi-fold increase in wealth, preservation of such wealth, ensuring continuity of leadership, organizational stability, wealth management, providing for the loved ones, and avoiding disputes within family, is gaining prominence. This has necessitated the need for a legally and tax efficient estate or succession planning.
2. KEY TAX CONSIDERATIONS AT THE TIME OF SETTLEMENT
2.1 The tax implications arising from the settlement of property into a trust are governed by Section 47 of the Act in the hands of the settlor, and by Section 56(2)(x) of the Act, in the hands of the trust / beneficiary.
2.2 Section 47 of the Act provides an exemption for the transfer of a capital asset by an individual to an irrevocable trust. Therefore, the settlement of property by an individual settlor to an irrevocable trust is not subject to tax, in the hands of the settlor.
2.3 Section 56(2)(x) of the Act inter alia provides that receipt of a specified property4 by any person without any consideration will be liable to tax at Fair Market Value ("FMV") in the hands of the recipient. However, an exclusion is provided for a case when a specified property is received from an individual by a trust created or established solely for the benefit of the relative5 of the individual. Therefore, when a trust is established solely for the benefit of the relatives of the settlor, receipt of any specified property by the trust upon settlement is not subject to tax.
This article analyses a recent ruling, dated December 30, 2024, of the Income Tax Appellate Tribunal, Bangalore Bench ("Tribunal"), in the case of Buckeye Trust v. PCIT6, wherein, inter alia the Tribunal held as under:
- An "interest in partnership firm" falls within the scope of the term "shares" and thereby constitutes specified property for the purpose of section 56(2)(x); and
- The power of the trustee to include beneficiaries (including non-relative beneficiaries) results in the trust not being established solely for the benefit of relatives, thereby attracting the provisions of Section 56(2)(x) of the Act. Consequently, any property transferred to the trust upon its settlement (without any consideration) will be liable to tax under this section.
2.5 It is pertinent to note that the Tribunal, on its own motion on January 7, 2025, recalled the entire order for a fresh hearing due to certain inadvertent errors in the original order. This matter is now fixed for hearing on February 19, 2025.
3. FACTS AND ISSUE
3.1 Buckeye Trust ("Taxpayer or "Trust") is a private discretionary trust established under the provisions of Indian Trust Act, 1882 pursuant to a settlement deed ("Deed") dated January 23, 2018 executed between Mr. Anand Nadathur, as the settlor ("Settlor") and Vervain Management Private Limited, as the trustee ("Trustee").
3.2 The Settlor contributed investments comprising of "interest in partnership firms" and "equity and preference shares in unlisted companies" aggregating to INR 669.28 crores, to the Trust out of natural love and affection. On the same day, the constitution of all partnership firms was changed, whereby the Taxpayer was admitted as a partner in all the partnership firms through the Trustee, and the Settlor retired from these firms.
3.3 In the original scrutiny proceedings under Section 143(3) of the Act, the returned income of the Taxpayer was accepted by the tax officer without any modification.
3.4 However, the Principal Commissioner of Income-tax ("PCIT") took a view that the order passed by the tax officer was erroneous and prejudicial to the interest of revenue, and accordingly initiated proceedings under Section 263 of the Act.
3.5 The PCIT, upon examining the Deed, held that the Trust was not established solely for the benefit of relatives, as the Trustee was empowered to add other persons (including non-relatives) as beneficiaries, and therefore, an amount of INR 669.28 crores received by the Trust should be brought to tax under the head "Income from Other Sources" under Section 56(2)(x) of the Act.
3.6 Aggrieved by the order of PCIT, the Taxpayer preferred the appeal before the Tribunal.
4. TRIBUNAL'S DECISION
4.1 Based on these facts, the Tribunal's judgement can be categorised into three key aspects.
A. Trust established solely for relatives excluded from the ambit of Section 56(2)(x) of the Act
4.2 The Taxpayer contended that the Trust was established for the benefit of relative beneficiaries, and therefore the provisions of Section 56(2)(x) of the Act should not apply.
4.3 Upon examining the Deed,7 the Tribunal observed that the Trustee was empowered to include any person, including non-relatives as beneficiaries in the Trust. Therefore, the benefit of the settled assets was not confined only to family members. Consequently, the Tribunal concluded that the provisions of Section 56(2)(x) of the Act would be applicable in this case.
B. Interest in partnership firm falls within the scope of expression "shares"
4.4 The Taxpayer further contended that even if it falls within the rigors of Section 56(2)(x) of the Act, the "interest in partnership firm" is not covered within the definition of "property" as defined for the purpose of Section 56(2)(x) of the Act.
4.5 The Tribunal proceed to examine whether interest in partnership firm would fall within the scope of expression "property".
4.6 The detailed analysis undertaken by the Tribunal is summarized as under:
- The Tribunal noted that the expression "property" has two ingredients i.e. "shares and securities".
- Shares can be used more broadly to mean a part or portion of something. For instance, "sharing" refers to dividing or giving out portions of something among several people. It does not mean that the word share is only related to shares of corporate entity.
- The term "securities" encompasses a broader range of financial instruments including shares, bonds, debentures, etc.
- The Tribunal further relied on certain judicial precedents8 to note that shares is a species of security.
4.7 Based on the above, the Tribunal held that the expression "shares and securities" denotes two different types of properties, and the term "and" used between them carries a meaning of "or". In order to interpret this, the Tribunal referred to the following principles of interpretation of statutes and various other judicial precedents.
- The court may deviate from literal interpretation when it leads to absurdity and may interpret "and" for "or".
- If the context of the statute, regulation or contract suggests that "and" should be read as "or".
- If the legislative intent behind the statute or regulation is to provide alternative options, courts may interpret "and" as "or".
4.8 The Tribunal further held that if the definition for a particular word is not provided, the courts or authorities have the power to interpret the word according to its common usage or the broader context. Accordingly, the meaning of the term "share" should not be restricted to shares of a company but would broadly mean a part or portion of something.
4.9 Further, the Tribunal relied on certain judicial precedents9 to hold that interest in partnership firm is nothing but shares of a partnership firm. It includes proportion of ownership and right to participate in the management of the partnership firm.
4.10 Therefore, the Tribunal held that "interest in partnership firm" would fall within the category of "shares" and thereby the provisions of Section 56(2)(x) of the Act will be applicable in this case.
C. Settlement of Trust is without consideration
4.11 On the basis of the provisions contained under the Indian Trust Act, 1882, the Taxpayer contended that the assets received by the Trust are not "without any consideration" based on the following premise:
- The Trust itself is an obligation, and each receipt by the Trust is an obligation that the same will be used for the benefit of beneficiaries.
- The assets are received by the Trust in fiduciary capacity.
- The Trust via the Trustee does not have any right to enjoy the receipt as owner.
4.12 However, the Tribunal rejected the above contentions of the Taxpayer.
4.13 Conclusion / Decision: In conclusion, the Tribunal, inter alia, held that:
- "interest in partnership firm" would fall within the category of "shares" and thereby the provisions of Section 56(2)(x) of the Act will be applicable; and
- settlement of a discretionary Trust in which the Trustee has the authority to add non-relative beneficiaries will fall within the ambit of Section 56(2)(x) of the Act.
5. ANALYSIS / COMMENTS
5.1 This is one of the most intriguing judgments, and everyone in the tax fraternity will closely monitor its future trajectory.
5.2 There is no universally prescribed method for formulating an estate plan. The structuring is predominantly influenced by legal and tax framework. However, the outcome of this ruling will certainly play a pivotal role in estate and succession planning.
5.3 In the present case, the trust was constituted for the benefit of the settlor, his spouse, children, and grandchildren. Although, at the time of settlement, no non-relatives were designated as beneficiaries, the trust deed conferred power upon the trustee to add any person or class of persons as beneficiaries. Given that this authority was not restricted to relatives alone, the Tribunal held that the trustee could include non-relatives as beneficiaries, thereby invoking the provisions of Section 56(2)(x) of the Act.
5.4 It is customary for trust deeds to include a general clause granting power to the trustee to add beneficiary at a later stage. In practice, it is observed that while such standard clauses are often incorporated, non-relatives are generally not added as beneficiaries. The fundamental issue, therefore, is whether the mere possibility of including non-relatives as beneficiaries could jeopardize the trust's status and subject it to adverse tax implications under Section 56(2)(x) of the Act.
5.5 While, going forward, it will be imperative to draft trust deeds with greater precision and attention to detail to mitigate the risk of protracted tax disputes, this decision opens a pandora's box of ambiguity regarding tax liability of existing trusts containing such general clause.
5.6 Further, this ruling not only affects the taxation of discretionary trusts, but also has broader ramifications for the other taxpayers, particularly regarding the applicability of Section 56(2)(x) of the Act, to "interest in partnership firms" and other jointly held capital assets.
5.7 The Tribunal held that the term "shares" is not restricted to the shares of companies alone, but it is wide enough to mean a part or portion of something. Consequently, this interpretation may not be limited solely to interests in partnership firms but could also extend to shared interest in other types of entities, such as beneficial interest in a private trust, Hindu Undivided Families (HUFs), Associations of Persons (AOPs), and Bodies of Individuals (BOIs).
5.8 Moreover, this interpretation could potentially extent to shared ownership or interest in other capital assets, including as plant and machinery, intellectual property, intangibles, etc. While such assets are not explicitly covered under the term "property", the key question is whether their joint ownership alone is sufficient to bring them within its purview for the applicability of Section 56(2)(x) of the Act.
5.9 If this broader interpretation is applied, the ruling could have significant implications for a wide range of transactions. Therefore, each case should be carefully examined based on the specific facts to determine the potential tax impact.
5.10 There is a pressing need for legislative clarification to explicitly define whether the intent is to include an interest in a partnership firm or any other shared interest within the scope of Section 56(2)(x) of the Act. Moreover, caution must be exercised in drafting trust deeds, particularly with respect to specifying the powers conferred upon the trustee and identifying the designated beneficiaries.
5.11 Succession and estate planning process is guided by several factors. While the plan must adhere to wishes of the settlor, it must be legally and tax efficient, and easy to implement without creating uncertainty around potential liabilities for the beneficiaries. The principles outlined in the Buckeye trust ruling could potentially act as a hindrance to estate and succession planning. While greater insight is expected post fresh hearing from February 19, 2025, the Central Government may consider addressing this issue and provide clarity in the upcoming Union Budget 2025.
Footnotes
2 Section 3 of the Indian Trusts Act 1882.
3 Section 160 of the Income Tax Act, 1961 ("Act").
4 The term "property" is defined under explanation (d) to Section 56(2)(vii) to mean the following capital asset of the assessee, namely:— (i) immovable property being land or building or both; (ii) shares and securities; (iii) jewellery; (iv) archaeological collections; (v) drawings; (vi) paintings; (vii) sculptures; (viii) any work of art; or (ix) bullion.
5 The term "relative" is defined under explanation (e) to Section 56(2)(vii) to mean in case of an individual - (A) spouse of the individual; (B) brother or sister of the individual; (C) brother or sister of the spouse of the individual; (D) brother or sister of either of the parents of the individual; (E) any lineal ascendant or descendant of the individual; (F) any lineal ascendant or descendant of the spouse of the individual; (G) spouse of the person referred to in items (B) to (F).
6 ITA No. 1051 / Bang / 2024.
7 The relevant extract of the clause is reproduced below:
"1.6 Beneficiaries" means the beneficiaries of this
Trust, which constitute: a) The Settlor; b) The spouse of the
Settlor; c) The children and remoter issue of the Settlor; and d)
Such other objects or persons as are added under clause 6 and
"Beneficiary" shall be construed accordingly.
...
6.1 The Trustee may, at any time during the Trust Period, declare
that any person or class of persons (whether or not in existence or
ascertained) or Charity shall be added to the class of
Beneficiaries provided that no such person or class of persons or
Charity may be or include any Excluded person."
8 Durrani Abdullah Khan v. State of Maharashtra (2017) 4 AIR Bom R 300; Jindal Stainless Ltd. v. State of Haryana (2017) 12 SCC 1 / [2016] 75 taxmann.com 137 (SC); Barun Kumar Vs State of Jharkhand- (2022) SCC online SC 1093; Akshaibar Lal (Dr.) v. Vice-Chancellor, Banaras Hindu University (1961) 3 SCR 386; Remsons Industries Ltd. v. National Stock Exchange of India Ltd 168 Taxman 458; Water Health India (P.) Ltd. (2020) 116 Taxman.com 270 (AAR); Ishwar Singh Bindra v. State of UP AIR 1968 SC 1450.
9 CIT Vs Raman Chettiar 57 ITR 232(SC); K. Rukmani Ammal v. K. Balakrishnan (1973) 91 ITR 631 (Madras High Court); S. Gurunarayana v. S. Narasimhulu (2004) 7 SCC 472 (SC); Sudhir Gopi v. Usha Gopi (2018) 14 SCC 452 (SC).
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