What is Trust?
A Trust is a legal arrangement in which a person’s property(Settlor/Donor) or funds are entrusted to a third party(Trustee) to handle that property or funds on behalf of a beneficiary.
Benefits of a Private trust:
- Effective and efficient mode of managing and passing of family assets.
- In creation of Trust, court does not oversee the process unlike at the time of execution of Will.
- Safeguards interest of family members including maintenance of members with special needs.
- Avoids family disputes.
- Conditions can be attached such as attainment of particular age/fulfillment of authors’ wishes.
PARTIES IN A TRUST:
1. Settlor/Donor:
The person who creates the Trust and transfers his property in a Trust at the time of creation of Trust and subsequently after creation of trust.
2. Trustee:
The person to whom the settlor/donor trusts and to whom the settlor/donor transfers his funds or property to look after for the benefit of the beneficiaries. He is the legal owner of assets and is responsible for managing the trust assets and for legal compliances.
3. Beneficiary:
The person who is entitled to the income and assets of the trust as laid down in the trust deed. The beneficiary may be specifically identified or they are broadly defined. The beneficiaries can be the person who may not exist at present but may exist at a later date or at the time of dissolution of the Trust eg. Sons and Grandsons.
Only OCI cardholders can be the beneficiaries in the Trust.
4. Protector / Mentor:
Protector/Mentor is a person appointed under the Trust deed to direct or restrain the trustees to ensure that the trustees exercise their administrative powers in accordance with the intentions of the settlor/donor.
If the Settlor/Donor is appointed as Protector/Mentor, then he shall retain dominant powers of the trust and can lead to Trust being treated as revocable trust. Therefore, it is advisable to appoint another person as a Protector/Mentor.
PRIVATE TRUST AND ITS TYPES:
When the trust is established for family members, relatives, friends, etc. then the trust is called a Private Trust. The formation of a private trust gives this transaction a legal form and guarantees that money is used only for the benefit of his/her family and in the way the trustee wishes it to be handled.
A. Revocable & Irrevocable Trust :
(i) Revocable Trust:
- A trust which can be cancelled at any time, till the survival of the settlor/donor.
- In spite of the transfer of the asset, the settlor/donor can exercise his control and power over the property transferred.
- The terms of the contract can be altered or amended at any time, during the life of the settlor/donor, in a revocable trust.
- As per Section 61 of the Income Tax Act, the trust is disregarded and the income is taxed in the hands of the settlor. The section has been phrased here under:
”All income arising to any person by virtue of a revocable transfer of assets shall be chargeable to income-tax as the income of the transferor and shall be included in his total income.”
- Therefore, in case of revocable trust as per Income tax act, the trust shall not be considered as a separate legal entity so the very purpose of creating a trust would stand defeated.
(ii) Irrevocable Trust:
- A trust that cannot be cancelled, once it comes into effect.
- The settlor/donor cannot exercise his control and power on the asset within the trust and the terms of an irrevocable trust cannot be modified.
B. Irrevocable Specific Trust/ Determinate Trust/ Non-Discretionary Trust and Irrevocable Discretionary Trust/ Indeterminate Trust:
(i) Irrevocable Specific Trust/ Determinate Trust/ Non-Discretionary Trust:
A trust where the beneficiaries are identifiable and their shares are determinate.
(ii) Irrevocable Discretionary Trust:
A trust where the beneficiaries are not identifiable and their share are indeterminate.
C. Testamentary and Non-Testamentary Trust:
(i) Testamentary Trust:
The trust which is created under a Will. The trust becomes effective when the settlor dies and are subject to Indian Succession Act,1925.
(ii) Non-Testamentary Trust:
The trusts which is settled and executed by a settlor during his lifetime. The trust becomes effective when created or upon the occurrence of a specific event stated within the trust deed.
TAXATION OF TRUST:
A. Taxation on the creation of Trust corpus:
i) Taxation to the Settlor:
Where a settlor irrevocably transfers any assets by way of a trust to an irrevocable trust, then such transfer would be exempt from taxation for the settlor as per section 47(iii).
The extracts of Section 47 (Transactions not regarded as transfer) are phrased hereunder:
Nothing contained in section 45 shall apply to the following transfers:—
(iii) any transfer of a capital asset under a gift or will or an irrevocable trust.”
The recipient i.e. the beneficiary/trustee will get the cost of acquisition of the previous owner as per section 49(1)(iii)(d) and even the period of holding would include the period for which such asset was held by the previous owner.
ii) Taxation to the Trust on receipt of assets from the settlor:
The amount received by the trust from the settlor is exempt under Proviso to Section 56(2)(x). The Section is phrased hereunder:
As per Section 56(2)(x) of the Income Tax Act, where any person receives, in any previous year, from any person or persons on or after the 1st day of April, 2017, —
(a) any sum of money, without consideration, the aggregate value of which exceeds fifty thousand rupees, the whole of the aggregate value of such sum;
(b) any immovable property,
(c) without consideration, the stamp duty value of which exceeds fifty thousand rupees, the stamp duty value of such property shall be chargeable to income-tax under the head ‘Income from other sources.
However, the Proviso to Section 56(2)(x) excludes the amount from an individual by a trust created or established solely for the benefit of relative (as defined under the Income Tax Act) of the individual.”
B. Tax on regular incomes of Private Trust:
i) Taxation in case of Irrevocable Specific/Non- Discretionary Trust:
In case of Specific Trust, rate of tax of trustee would depend upon the status of the beneficiaries to the extent of their share as per Income Tax Act. However, the income can be taxed either in the hands of beneficiaries directly or trustees in their capacity of representative assessee. However, there would be no double taxation, this has been clarified by the Board Circular No. 157 dt. 26.12.1974.
If there is Income other than business income, the rate of tax would be same as applicable to the beneficiaries.
If the total income includes Short term capital gain or long term capital gain, then this income shall be charged at the rates specified under the relevant sections, not at Maximum Marginal Rate.
If there is business income, then tax shall be at Maximum Marginal Rate on the whole income by virtue of Section 161(1A) of Income Tax Act.
There is one exception where MMR is not applicable when the trust is declared by any person by will exclusively for the benefit of any relative dependent on him for support and maintenance & such trust is the only trust declared by him.
ii) Taxation in case of Irrevocable Discretionary Trust:
The income of the trust will be assessed in the hands of the Trust.
If the total income includes Short term capital gain or long term capital gain, then this income shall be charged at the rates specified under the relevant sections, not at Maximum Marginal Rate.
On the total income, Maximum Marginal Rate of tax will be applicable.
However, there are Proviso which states that MMR shall not apply in few circumstances, instead tax rates applicable to AOP shall apply i.e., slab rates.
C. Benefits of individual available:
All the benefits, deductions of allowances which an individual beneficiary could have obtained are also available to the trustees assessed in representative capacity – for instance benefit u/s. 54 of the Act.
DISTRIBUTION OF ASSETS/TERMINATION OF A TRUST
As per Section 56(2)(x) of the Income Tax Act:-
Where any person receives, in any previous year, from any person or persons on or after the 1st day of April, 2017, —
(a) any sum of money, without consideration, the aggregate value of which exceeds fifty thousand rupees, the whole of the aggregate value of such sum;
(b) any immovable property, (A) without consideration, the stamp duty value of which exceeds fifty thousand rupees, the stamp duty value of such property shall be chargeable to income-tax under the head ‘Income from other sources.
Applying the above provision, when the trust distributes any assets to the beneficiaries on the dissolution of a private family trust set up in India, the same shall not be considered to be received ‘without consideration’ and therefore shall not be chargeable to tax under the head ‘Income from other sources’.
OPERATIONS OF THE TRUST:
i) Number of Trustees:
There is no restriction on number of trustees. Minimum 2 trustees are required for easy management of the Trust.
ii) Banking regulations for the trust under FEMA:
The Specific Family Trust shall open a NRO Account for its banking operations, if the residential status of the trust is that of Non-Resident under FEMA.
iii) Administrative office:
The trust needs to have an administrative office in India with the evidence of the trust having a lawful right to use that premise as an administrative office. That office has to be operative as communications regarding the trust would be routed there.
iv) Registration of Trust:
If the trust property is immovable property, Section 5 of Indian Trust Act requires that a registered deed to be executed unless the trust is created by Will or the settlor himself is the sole trustee.
If the trust property is movable property, Section 18 of Registration Act, 1908 states that registration of deed is optional where instruments which purport or operate to create, declare, assign, limit or extinguish any right, title or interest to or in movable property.
- DISCLAIMER:
The above opinion is based on our interpretation of the existing law and regulation in force. We have cited the relevant circular/section/extracts of law relied upon along with our analysis and interpretation in formation of the above opinion for the matter. However, as a matter of mere caution or prudence or for any other reason, if the stakeholders of the trust find it necessary to seek the approval of the Reserve Bank of India, we would advise you to proceed with the same to ensure complete confidence in the process of formation of the trust.
