How to save Trust tax – Strategies from Udaipur CA

Trusts can save significantly on income tax with the right planning. A leading Udaipur CA shares how to pay at slab rates instead of maximum marginal rates. Gain expert insights from the best Chartered Accountants in Udaipur.

Section 3 of the Indian Trusts Act, 1882 (‘ITA’) defines ‘Trust’ as:

 “an obligation annexed to the ownership of the property, arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him for the benefit of the another, or of another and the owner”

Thus in the trust an obligation casted on the trustee by the settlor to employ the trust assets for the benefit of the beneficiaries.

Types of trust

1. Specific Trust where the shares of beneficiaries are specified
2. Discretionary Trust where the distribution to the beneficiaries is at the discretion of the trustee.

How to create trust?

Trusts are created when the settlor of the property transfers a property to the trustees for its usage for the specified objects.  Four essential conditions are necessary to bring into being a valid trust.

1. The person who creates a trust (settlor) should make an unequivocal declaration binding on him.
2. Settlor/author must transfer an identifiable property under irrevocable arrangement and totally divest himself of the ownership and the beneficial enjoyment of the income from the property
3. The objects of the trust must be defined and specified.
4. The beneficiaries must be specified.

Settlor / Author

Settlor / Author are the person who settles the trust. He can be a trustee or a beneficiary as well. Settlor should be a person competent to contract. A Settlor has no role to play in the operations of the Trust. Settlor decides Original Trustee, the Trust framework and initial beneficiaries of the Trust

Trustees

Trustee is the persons who are bestowed with the responsibility of managing the assets of the trust and rights and powers for wealth distribution. Trustee should all living natural persons or legal persons – competent to contract. Trustee operate the Trust as per the objects of the Trust

Beneficiaries

Beneficiaries are the persons for whom the trust has been settled.  There is No restriction on number of beneficiaries. Every person capable of holding property can be beneficiary. A minor / a person with mental disability can be a beneficiary. A trust can be a beneficiary in another Trust. Beneficiaries enjoy profits of the trust property.

Save Income Tax through Family Trust

Family trusts is an important tool for tax planning and it plays a vital role in life of a person. Sections 160, 161,162 & 164 of the Income Tax Act, 1961 contains the provision of assessment of trust and its taxation.

Family Trust

Income of a family trust (hereinafter referred to as a trust) may be taxable at the normal slab rates of income tax, or in some rare cases may become liable to a maximum marginal rate of income tax.

Assessment of Business Income of a Trust

Section 161(1A) of the IT Act states that if trust income includes income  from  profits and gains from business, then  entire income of the trust including any profits and gains from business would be liable to income tax at the maximum marginal rate.

So While doing the trust tax planning, the trustee should keep in mind that trust should  not have any income in the nature of profits and gains from business  otherwise the entire income of the trust would become liable to maximum marginal rate of tax, namely, 30%

Exception:

However, exception provided in the proviso to Section 161(1A),  that maximum marginal rate on the whole of income of a trust which includes profits and gains in business would not be applicable and the tax on the business income of the trust would be chargeable at normal slab rates of income tax, subject to satisfying the following three conditions:

The profits and gains are receivable under a trust which is declared by any person by Will;

Such profits are exclusively for the benefit of any relative dependent on him for support and maintenance [“Relative” as per Section 2(41) means the husband, wife, brother or sister or any lineal ascendant or descendant of that individual]; and

Such trust is the only trust so declared by the person through the Will.

Trust for Minors

If trust is to be created for the benefit of a minor, the income could be chargeable in the hands of a guardian of the minor as direct assessment of the beneficiary is not barred as per Section 166 of the IT Act.

However, the investment income of the minor is includible in the income of the father or mother as the case may be. Tax advantage may not be available for making a 100% specific beneficiary trust for a minor.

Hence while creating the trust for the benefit of the minor, there is should be clause for the benefit of the minor stating that the income of the trust would not be applied for the benefit of the minor during the course of minority of the beneficiary. By including this clause in the trust deed, the income of a minor beneficiary will not be clubbed with the guardian under the provisions of Section 64 of the IT Act and the income of the trust would be assessable in the hands of the trustee in the normal manner.

Unborn Persons as Beneficiaries

Trust can be created for the benefit of living as well as unborn person who are not in existence and  unborn persons could be made beneficiaries i.e. an unborn son/daughter  or and other charitable institutions, schools, hospitals can  be beneficiaries under a trust.

A trust created for the benefit of the future wife of a minor son is valid only, if there is a provision in trust deed that that the minor will will not marry during his lifetime and its benefit will go to the future wife of the other minor son, provided that in case both the minor sons are not married, then profit will be used for charitable purposes.

Discretionary Trusts

In such type of trust, Trust deed of a discretionary trust does not identify specific ratio, but empowers trustee or other person to determine the share of beneficiaries.

Section 164(1) provides that “where any income of a trust in respect of which a trustee is liable as representative assessee or any part thereof is not specifically receivable on behalf of or for the benefit of any one person, or where the individual shares of the persons on whose behalf or for whose benefit such income or such part thereof is receivable are indeterminate or unknown, then tax would be charged on the relevant income or part of the relevant income at the maximum marginal rate.

Thus, such a trust which is popularly known as a “discretionary trust”, is chargeable to income tax at the maximum marginal rate, i.e., 30% subject to complying the other provision of the Income tax Act.  

Trust for a Deity

A trust can also be created for the benefit of deity. Where the Author/setllor  gave away his estate to the deity and created an absolute debutter thereof and obligated the managers of the debutter with responsibility to discharge certain secular or secondary behests including benefit to family members, their residence and transportation. Such trusts can also carry sole proprietary business and can also become partners in partnership business through the trustees or shebaits. The deed of dedication should specify that trust can do business. Such trusts are assessed as Artificial Juridical Person as per Sec. 2(3) (VII) of the Income Tax Act, 1961.  Hence, trust made for deity shall be assessed as Artificial Juridical person at the rate applicable to individuals

By employing proper tax planning, the income of a trust could be chargeable like an individual or an association of persons at the slab rates of income tax — and not at the maximum marginal rate of income tax.

Thus, a great deal of tax planning is possible in the matter of private and family trusts as briefly highlighted above and a good deal of income tax saving is possible for beneficiaries