Taxation of Private Trusts

Private trusts in India play a significant role in wealth management and succession planning. A private trust is established for the benefit of specific individuals rather than the public at large. When it comes to taxation of a trust structure there neither is a tax advantage nor any additional tax burden imposed by the Income Tax Act, 1961. However, the taxation of a private Trust is an intricate and complex issue.

The taxation of a Private Trust is done through taxation of the trustees. Under the Income Tax Act, trustees and beneficiaries are regarded as assessee and the income of the trust is taxed either directly in the hands of the beneficiary or in the hands of trustees as representative of beneficiaries or assesses.

Taxation of the Settlor: Section 47(iii) contains a specific exemption for any capital gains that may be considered to arise to the settlor or transfer of capital to an irrevocable Trust. Hence the settlor or the owner of the assets should not be liable to any tax or settlement of the irrevocable Trusts. Under the revocable Trust, clubbing provisions would apply and the income arising by virtue of revocable transfer of assets shall be chargeable to tax in the hands of the transferor or settlor. The above provisions are only for the purposes of taxability of the transfer and does not in any way affect the contractual rights and obligations as may be prescribed in the trust deed.

Taxation of the beneficiaries: Section 56(2)(x) of IT Act provides for the taxation of the value of the assets in the hands of the beneficiaries of such assets. When assets are settled under a Trust, by assuming the beneficiaries as the relatives of the settlor within the definition of ‘relatives’ as prescribed under the IT Act, then no implications would arise under the aforementioned section. The section was formed under the introduction of Finance Act, 2017. The said section is applicable to the beneficiaries only and does not apply to the trustees when it comes to the taxation under section 56(2)(x), as a trustee receives the property with an obligation to hold it for the benefit of the beneficiaries.

For the purpose of taxation, a Trust can be classified into two types: Specific Trust and Discretionary Trust.

Specific or discretionary Trusts are adopted based on the distribution pattern. If the Trust deed provides a list of beneficiaries specifying their beneficial interest it would be a specific Trust. If the Trust deed does not specify any beneficiary’s share, but empowers the Trustees to determine such share, it is considered as a discretionary/indeterminate Trust.

When it comes to the taxation of the specific Trust, the tax is determined as an aggregate of the tax liability of each of its beneficiaries on their respective shares unless the Trust earns business income.

The taxation of the discretionary Trust is taxed in a way that the maximum marginal rate applicable to the type of income earned by the Trust.

Distribution of assets/termination of a Trust

There are no specific statutory provisions that deals with the dissolution of the Trust/taxability on distribution of the assets of the Trust. As a Trust holds assets for the benefit of the beneficiaries, distribution of the Trust assets to the beneficiaries does not result in any income taxable under the Income Tax Act.