What The Law Says About Taxation Of A Private Trust
Private trusts are formed for estate planning and succession of property. They are often seen as a mode for protection of wealth and welfare of those dependent on the owner or settlor. Across India (except Jammu & Kashmir and Andaman and Nicobar Islands), private trusts are governed by the Indian Trust Act, 1882. The law, however, is not applicable on Waqf, Hindu Undivided Family or charitable endowments.
What is a private trust?
According to the legal definition, a trust is an obligation annexed to the ownership of property and arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him, for the benefit of another or of another and the owner. In simpler terms, a trust facilitates transfer of property or assets by the settlor to another party (trustee) for the benefit of the third party (beneficiaries).
Trusts are of two kinds - Public Trust (where the number of beneficiaries is uncertain) and Private Trust (where the beneficiaries are definite).
Taxation of a private trust
The beneficiaries of a trust enjoy the rights to the rents and profits of the trust property (subject to the trust deed). The income generated out of a private trust is available only to the beneficiaries and the taxability of that income varies on the basis of the structure adopted. The structures can be of two kinds based on the shares of a beneficiary:
Specific trust: In this case, the income is received by the trustee as a representative assesse on behalf of a beneficiary. The share received by a beneficiary should be clearly stated. For instance, if an X beneficiary receives 50 per cent of the total income of the trust, the tax is recovered as per the rate applicable to the total income of the beneficiary. As income-tax rules mandate the liability to pay tax on trustees, the tax can be levied and recovered from the representative assesse.
Discretionary trust: In this case, the individual shares of the beneficiaries are not known, and the trustees decide the distribution of the income among the beneficiaries. The income of such a trust is assessed in the hand of the trustees as per the tax bracket under which they fall.
Taxability of business income
The above stated rule is applicable only when the income source of the private trust is obtained from its assets. When the income of the trust consists of profits and gains of business, the taxation is different. If the private trust is involved in a business, the proceeds of the business form the property of the trust and the trustees (or author of the trust) cannot stake a claim. The entire income of the private (specific) trust is then charged on the maximum marginal rate. That is, the income will be charged at the same rate and in a manner as it would be taxed in the hands of the beneficiary.
The above tax rule does not apply if:
- The private trust is created by a will from which business income is obtained.
- It is created exclusively for the benefit of certain relatives of the settlor for support and maintenance.
- It is the only trust declared by the settlor.
Tips when forming a private trust
- Trust of a personal property can be formed by the settlor's spoken statements. It is then referred to as Oral Trust. It should be avoided as the tax on the income of an Oral Trust is charged on the maximum marginal rate.
- Refrain from carrying out any business activity from the private trust.
- Beneficiaries of a private trust should not be the beneficiaries of any other trust, as the tax is again charged at the maximum marginal rate.
- A private trust should be made 100 per cent specific beneficiary for major son or daughter. It will ensure that money is not misused by the son in future or relatives of the daughter when she gets married.
- If the beneficiary is your minor child or spouse, the capital of the trust should not be through the parent or father-in-law or husband of the beneficiary. In such a case, the income will get clubbed with them, as per the Clubbing Provision under Section 64 of the Income Tax Act.