Taxation of Private Trust
Although there is a lot of consideration before a private trust can be created one very important element which is required to be addressed is the taxation. The primary reason is that income of a private trust is taxed differently in different structures and any ineffective planning can lead to maximization of taxation for this entity.
Generally private trusts are taxed according to the income received by the beneficiaries since the income is available only to them. The income will be taxed according to the structure whether it’s a specific trust or discretionary trust. If it’s a specific trust then the income is taxed in the hands of the beneficiary or can be recovered from representative assesse which is the trustee. Contrary to this in a discretionary trust the income is taxed at the marginal maximum rate since the distribution of the income is decided by the trustees.
Now the above taxation rules apply when the income is generated only from the assets of the trust. However, a private trust may have other source of income like a business income. If it is so, then the income of the trust will be taxed at maximum marginal rate except in below three situations where the taxability remains at individual level:
- When a private trust is created by a Will for the benefit of relatives
- It is created exclusively for the benefit of any relative dependent on the support and maintenance
- It is the only trust declared by the settlor
One larger point to be noted is that there is no basic exemption available when the taxability is at maximum marginal tax rate.
Clubbing of The Trust Income
One important consideration in case of taxation of Trust is Clubbing of Income provision under Section 64(1). The provision relates to the clubbing of income of spouse or minor child if the assets are gifted from spouse or parents. This provision impact the taxability of income from the assets gifted to the trust. In the case of private trust too if the trust is created for the immediate or deferred benefit of any individuals spouse and such person transfers any assets by way of gift, the income from such assets arising in the trust will get clubbed with income of such individual, i.e. the person transferring the assets. Similarly a father-in-law or mother-in-law transfers any gift to this private trust then also the provision of clubbing of income as per Income Tax will apply. Thus, for an effective tax planning the husband, father-in-law or mother-in-law should not make any gift to any trust or the benefit of the taxpayer spouse. In other situation the income of minor children, with exceptions, would be clubbed with income of father or mother whoever has higher income during period of minority. In a nutshell, care has to be taken while gifting the trust to avoid this clubbing of income.
Tips for Tax Planning Through Trust
When you are creating a private trust you are actually creating a separate tax entity and so care has to be taken not to maximize the taxability on the income of the trust. Here are few tips on how you can ensure the taxability of the private trust income stays lower and it meets the objectives in an efficient manner:
- Avoid any business activity from the private trust you create for the benefit of your relatives.
- Ensure same beneficiaries are not created in more than one trust.
- For an effective tax planning the husband, father-in-law or mother-in-law should not make any gift to any trust created for the benefit of the taxpayer spouse.
- If the trust is for minor son or daughter, ensure the trust is 100% specific beneficiary trust and created with provision of deferment of benefit during minority of child because once child is major the provision do not apply.
One of the major consideration for families forming a trust is whom to appoint trustees. This is primarily due to the fact that the position of a trustee is an important one where trustees are in “Fudiciary” Relationship with the trust beneficiaries. If they are not able to fulfill their duties then there are numerous provisions through which they can be held liable for “breach of trust”.
Section 10 of Indian Trust Act lays down that any person capable of holding a property can be appointed as a trustee. Even a minor can be appointed as a trustee if the role of the trustee is passive in nature without any discretion. Any corporation, a company, an individual or an association of persons can be appointed as trustees in a private trust. For any family identifying a suitable trustee requires a good amount of work. If there are any identifiable trustees then the provision of giving them first invite can be added in the trust deed while in future provision of making a professional or corporate as a trustee can also be added in the trust deed. Thus, based on one’s requirement and structure of a trust necessary provisions can be made in the trust deed for appointing suitable trustees.
NRI As A Trustee?
There are many families who does identify a suitable trustee for their trust but he/she has an NRI status. The larger question which then emerges is that – Can an NRI who resides abroad and unable to participate in the daily functioning of the trust be appointed as a trustee?
Here one has to look at the provisions of the Indian Trust Act very closely. Although the act does not bar appointment of NRI as a trustee, there are provisions which put restrictions on appointing NRI as a trustee. Sec 73 and Sec 60 are 2 such provision of this act.
Sec 73 States That
Whenever any person appointed a trustee disclaims, of any trustee, either original or substituted, dies, or is for a continuous period of six months absent from India, or leaves India for the purpose of residing abroad, or is declared an insolvent, or desires to be discharged from the trust, or refuses or becomes, in the opinion of a principal civil court of original jurisdiction, unfit or personally incapable to act in the trust, or accepts an inconsistent trust, a new trustee may be appointed in his place by…”
While Sec 60 States that
The beneficiary has a right (subject to the provisions of the instrument of trust) that the trust‑property shall be properly protected and held and administered by proper persons and by a proper number of such persons.
Explanation 1.–The following are not proper persons within the meaning of this section:
A person domiciled abroad; an alien enemy: a person having an interest inconsistent with that of the beneficiary: a person in insolvent circumstances; and, unless the personal law of the beneficiary allows otherwise, a married woman and a minor…”
Thus, looking at the above provisions it can be inferred that if the person is domiciled abroad for more than 6 months then it makes him unfit for the position to act as a trustee or he is not a proper person to be appointed. So the trust has to look for a new trustee. However, one should note that the removal of trustees cannot happen only on resident basis. There has to be a bad administration, incapacity to administer, insolvent, using trust property for own benefit or any other such reason for removing a trustee. Even if we look at Indian courts jurisdiction then a trustee has to be within the reach of the court to ensure the enforcement of the terms of the trust. So care has to be taken while identifying and appointing trustees for Indian Private Trust.
Considering all situations it may not be feasible to appoint NRI as trustees in Indian Private Trust.
This is second part of the detailed article on private trust. I will be covering the last and final part of this series wherein concept of living trust and a checklist for creating a private trust will be discussed.