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Estate & Succession Planning through Wills, Private Trusts & Nomination (V)
In the last issue of The Tax Talk, we have discussed the concept of Private Family Trust as a tool of succession planning. It is not a commonly used tool of succession planning though it could be one of the most powerful tools due to multiple reasons discussed in the last week. Let us know about the income tax law related to the taxation of the Private Trust.
Taxation of the Private Trust
Trusts may not always be an independent tax entity and may not be taxed separately in all the cases. The Income Tax Act imposes the liability to pay tax on the trustees (considered as Representative Assessee) in respect of any income received by the trust for the benefit of the beneficiary. The taxation of trust depends upon the nature of the trust which can be broadly categorised as under:
- Specific Trust:
When the individual shares of income of the beneficiary in a private trust is identifiable, then the trust is known as Specific Trust. In a specific trust, the income is specifically received by the representative assesses on behalf of a single or multiple identified & known beneficiary. Since the individual share of the beneficiary is known, it is taxable in the same manner and to the same extent as it is taxable in the hands of the beneficiary. In short, it can be taxed as if the amount is received by the respective beneficiary directly and is taxed at the applicable tax slab of the respective beneficiary.
- Discretionary Trust:
When the individual shares of income in a private trust is not specified or is not identifiable and the trustee has the discretion as far as distribution of funds is concerned, it is known as Discretionary Trust. Here, since the individual share of income of the beneficiary is not known, it would be taxable in the hands of the trust only. It is taxable at the Maximum Marginal Rate (MMR) which is presently 42.74%. Further, readers may note that whenever the trust is liable for taxation at MMR, the benefit of the basic exemption limit shall not be at all available.
- Revocable Trust & Irrevocable Trust:
If the trustee has power to revoke the assets transferred to the trust or take back the amount settled in the trust then the trust is known as revocable trust. However, where the author doesn’t have any such power, it is known as irrevocable trust.
Where a settler irrevocably transfers any asset and if such an asset is held as capital asset then such transfer would be exempt from taxation U/s 47(iii) of the Act. The clubbing provision in respect of income arising from the assets/property transferred is applicable where the transfer is done in by the author to a revocable trust.
- The tax provision as discussed above in case of all the trusts is applicable only if the trust doesn’t have any income from business. If private trusts have business income then the tax provision is different as discussed hereunder.
- If Trust has Business Income:
If trust has business income then the income earned from the business belongs to the trust and not to the author of the trust or trustees. All such income of a private trust which consists of profits and gains of business is taxable at a MMR.
However, there are certain exceptions whereby the taxability remains as per individual tax slab rate and not as per MMR if the following conditions are satisfied cumulatively:
a) When a private trust is created by a will for the benefit of relatives.
b) It is created exclusively for the benefit of any relative dependent on the support and maintenance.
c) It is the only trust declared by the settler.
In this scenario, even if there is a business income, the income will be charged at the same rate and in a manner as it would be taxed in the hands of the beneficiary.
- Taxation at Rates applicable to Association to Person (AOPs):
There are some instances in a private trust when the income of the trust can be taxed as if it were the total income of an AOP as under:
a) When none of the beneficiaries has any other taxable income which exceeds the Basic Exemption Limit (BEL). If there are multiple beneficiaries then income of the trust will be charged at MMR even if just one of the beneficiaries has taxable income above BEL.
b) When none of the beneficiaries is a beneficiary at any other trust. If even one is beneficiary at any other trust, the income will be charged at maximum marginal tax rate.
c) The income of the trust is receivable through declaration by any person under will and it’s the only trust declared by him.
d) If the income of the trust (other than created by Will) is created before 1.3.1970, exclusively for the benefit of the relatives of the settlor, or of the members of a Joint HUF when trust is created by family, in circumstances when the relatives or members were mainly dependent on the settlor of their support for maintenance.
e) Income is receivable by trust on behalf of superannuation fund, provident fund, gratuity fund, pension fund or any other fund created exclusively for the benefit of his employees.
The formation & taxation of private trusts is itself a vexed issue. I have made every attempt to keep it simple to the best possible extent. The above coverage may be taken as a tip to ensure that the tax impact is minimized keeping above in mind. From a taxation planning point of view, one should avoid any business activity in the private trust created for the benefit of the relatives and it should be a specific trust. If the trust is for a minor son or daughter or spouse, ensure the funds are not through father or husband since in that case the income will get clubbed with the income of the settlor/author.
With this, we come to an end of a 5 weeks series of the succession & estate planning through wills nomination, joint holding, family arrangement & settlement, gift & private trust. The fact remains; proper succession planning of the estates & business is the key to avoid the probable disruptions and conflicts amongst the family members.
[Readers may forward their feedback & queries at firstname.lastname@example.org. Other articles & response to queries are available at www.theTAXtalk.com]
CA Naresh Jakhotia
Partner – M/s. SSRPN & Co.
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