Introduction to Public and Private Trust
The Indian Trusts Act, 1882 defines a trust as being a legal obligation annexed to the ownership of property and arising out of a confidence reposed in the trustee by the settlor, for the benefit of the beneficiaries as identified by the settlor including / excluding the settlor himself. The person who reposes or declares the confidence is called the “author of the trust”; the person who accepts the confidence is called the “trustee”. The person for whose benefit the confidence is accepted is called the “beneficiary” and the subject matter of the trust is called “trust property”; the “beneficial interest” or “interest” of the beneficiary is the right against the trustee as owner of the trust property; and the instrument, if any, by which the trust is declared is called the “instrument of trust”.
When the trust is created for the family members, relatives, friends etc. the trust is called as Private Trust. And where the trust is created for the charitable or religious purpose where general public is the beneficiary, that trust is called as Public Trust.
The property in case of a trust is not transferred directly to the transferee but is put in control of the trustee for the benefit of the transferee. The trustee, depending upon the nature of the trust, either transfers the property or its earnings to the transferee at the happening of certain events or applies the property and /or its gains for the benefit of such a transferee.
A settlor may set up a revocable trust in order to exercise control over the assets and distributions of income and capital from the trust or an irrevocable discretionary trust in order to safeguard the assets against the claims of the creditors (actual and/or potential) of the settlor and/or the beneficiaries or multiple trusts to achieve various objectives. Indian trust law does not lay down restrictions with respect to a trust being set up with hybrid characteristics i.e. having both, determinate and discretionary features for different classes of assets in the same trust or provide a specific format for the trust instrument. This flexibility allows a trust structure to be devised to suit the specific needs and requirements of the settlor and eliminates the need to create multiple trusts.
Unlike most common law jurisdictions, Indian trust law does not recognize duality of ownership viz: legal and equitable. The trustee is the legal and beneficial owner of the trust property and the beneficiaries merely have a beneficial interest in such property. Private trusts in India (of a non-religious character) set up for the maintenance and support of the settlor’s family members, are also subject to the rule against perpetuity. This rule prescribes that a trust can be in existence for a period of 18 years from the date of death of the last existing beneficiary.
Purpose of Forming Private Trust
In India, trusts are also being increasingly used for succession planning and asset distribution, since they are considered to be one of the preferred modes of managing and passing on the family assets in the most efficient manner. Creating a legal framework for the family assets, bypassing probate process, safe-guarding interests of family members including maintenance of members with special needs/disabilities, attaching conditions to gifts (be it on attaining a particular age or fulfillment of the settlor’s wishes) and avoiding family disputes over the property being some of the prime considerations while designing a trust.
With large business houses in India being family-owned and controlled, a trust can serve as a bankruptcy remote protecting assets from creditor’s (actual and potential) claims, provided the assets have been transferred two years prior to the bankruptcy being declared. With managing and advisory committees being set up under the directions of the settlor, to monitor and advise the trustees on application and management of the trust assets, Indian trusts are being used as tools to bring a relatively large pool of assets/ investments under one umbrella, which has more scope to perform well than a series of smaller pools.
Taxation of Private Trusts in India
Trusts in India are fiscally transparent entities and the income of the trust is effectively taxed in hands of its beneficiaries. However, as envisaged under Chapter XV of the Income Tax Act, 1961 (“ITA”), the obligation to pay tax is on the trustee who does so in the capacity of a representative assessee8. The scope of this obligation extends to all income received by the trustee for the benefit of or on behalf of the beneficiaries to the trust. The trustee would be assessed to tax to the same extent that would be recoverable and levied upon the beneficiary. Hence, the aggregate liability of the trustee cannot be greater than the aggregate liability of the beneficiaries. At the same time, the trustee is entitled to recover the tax amount from the beneficiary.
The tax authority also retains the option of directly assessing the beneficiary to the trust in respect of its taxable income. However, the taxation of the trustee as a representative assessee is primarily a matter of fiscal convenience and expediency. Therefore, the tax is imposed on the person who receives the income (that is, at the earliest point) although he may not be entitled to the ownership and enjoyment thereof. The assessment of the trustee as a representative assessee is distinct from the assessment of his personal income. The income received by the trustee is taxed in a manner as if such income was directly received by the beneficiary. Therefore, the applicable rate of tax would depend on the type of income received on behalf of the beneficiary as well as the legal status of the beneficiary. If the beneficiaries are individuals, then the income received by the trustee would be taxed in accordance with the prescribed slabs applicable to the taxation of income received by an individual. But, if the beneficiary is a company, then such income would be taxed at the fixed rate applicable to companies.
If the income of the trust includes profits and gains of business or profession, then such income would be taxed in the hands of the trustee at the maximum marginal rate. Likewise, any income received by a trustee under an oral trust (as opposed to a written trust) would be also be taxed at the maximum marginal rate. However, if the income arises from property contributed by the beneficiaries through a revocable transfer, such income would be taxable in the hands of the beneficiaries.
With respect to discretionary trusts, where the income received by the trustee does not accrue to the benefit of a specific person or where the individual shares of the beneficiaries are indeterminate, such income would be taxable at the maximum marginal rate. However, this is subject to certain exceptions, for instance in the case of discretionary trusts declared by the last will of a testator, in which case the income would be taxable as if it accrued to an association of persons.
Therefore, while the manner in which the trust is organized would determine the applicable rates of tax, a trust, as such, is a pass-through entity, and although the income generated through the trust is taxable in the hands of the trustee, the burden of tax is effectively borne by the beneficiaries to the trust.
Cancellation and Revocation of a Trust
A trust is cancelled or extinguished in the following situations:
(i) when its purpose is completely fulfilled;
(ii) when its purpose becomes unlawful;
(iii) when the fulfillment of its purpose becomes impossible by destruction of the trust property or otherwise; and
(iv) when the trust, being revocable, is expressly revoked.
A trust is revoked at the pleasure of the testator. A trust otherwise created can be revoked only
(i) by consent of all the Beneficiaries (competent to contract);
(ii) where the Trust has been declared by a non-testamentary instrument or by word of mouth – in exercise of a power of revocation expressly reserved to the settlor of the trust; or
(iii) where the Trust is for the payment of the debts of its settlor and has been communicated to the creditors, by the settlor of the Trust.
To conclude trust vehicles, which were earlier essentially being used purely as testamentary vehicles for distribution of assets on the demise of the testator, are now being advantageously used for managing and investing assets, securing the interests of the beneficiaries by providing asset protection and ensuring distribution of income and assets as per the desires of the settlor. This can only be effectively achieved if the structure devised harmonises the strategic objectives of the settlor with the tax, regulatory and other aspects governing such trust structure.