ISSUE FOR CONSIDERATION
Section 160(1) treats the trustee as a representative assessee in respect of the income which he receives or is entitled to receive on behalf of or for the benefit of any person due to his appointment under a trust declared by a duly executed instrument in writing. Section 161 provides that tax on the income in respect of which the trustee is a representative assessee shall be levied upon and recovered from him in like manner and to the same extent as it would be leviable upon and recoverable from the person represented by him, i.e., the beneficiary.
Section 164(1) provides an exception to this general rule of taxation of the income of a trust. It provides that the tax shall be charged at the maximum marginal rate in certain cases and not the tax that would have been payable had it been taxed in the hands of the beneficiaries. The taxability at maximum marginal rate in the manner provided in section 164(1) will get triggered in a case where the income (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 is receivable are indeterminate or unknown. Such trusts are commonly referred to as discretionary trusts. Further, the Explanation 1 to section 164 provides as follows:
• Where the person on whose behalf or for whose benefit the income (or any part thereof) is receivable during the previous year is not expressly stated in the instrument of the trust and is not identifiable as such on the date of such instrument, it shall be deemed that the income is not specifically receivable on behalf of or for the benefit of any one person.
• Where the individual shares of the persons on whose behalf or for whose benefit the income (or part thereof) is receivable are not expressly stated in the instrument of the trust and are not ascertainable as such on the date of such instrument, it shall be deemed that the individual shares of the beneficiaries are indeterminate or unknown.
An issue has arisen about the applicability of the provisions of section 164(1) read with the aforesaid Explanation in the case of trusts (such as venture capital funds or alternative investment funds) where the persons who contribute the capital (contributors) under the scheme become beneficiaries of the income derived by the trust in proportion to the capital contributed by them. In such cases it is not possible to identify the beneficiaries and their share in the income of the trust at the time when the trust has been formed. Therefore, the trust deed does not list out the names of the beneficiaries and their respective shares in the income of the trust. Instead, it provides for the mechanism on the basis of which the beneficiaries and also their shares in the income of the trust can be identified from time to time.
The Bengaluru Bench of the Tribunal has held that it is sufficient if the basis to identify the beneficiaries and their share in the income of the trust is specified in the trust deed and it is not left to the discretion of the trustee or any other person. As against this, the Chennai Bench took the view that the income of the trust would be liable to tax at the maximum marginal rate in the absence of identification of the beneficiaries and their share in the income in the trust deed at the time of its formation.
THE INDIA ADVANTAGE FUND CASE
The issue had first come up for consideration of the Bengaluru Bench of the Tribunal in the case of
DCIT vs. India Advantage Fund – VII [2015] 67 SOT 5.
In this case, the assessee was a trust constituted under an instrument of trust dated 25th September, 2006. The settlor (ICICI Venture Funds Management Company Limited) had, by the said instrument, transferred a sum of Rs. 10,000 to the trustee (The Western India Trustee and Executor Company Limited) as initial corpus to be applied and governed by the terms and conditions of the indenture of trust. The trustee was empowered to call for contributions from the contributors which were required to be invested by the trustee in accordance with the objects of the trust. The objective of the trust was to invest in certain securities called ‘mezzanine instruments’ and to achieve commensurate returns for the contributors. The trust was to facilitate investment by the contributors who should be resident in India and achieve returns for such contributors. The trust deed provided that the contributors to the fund would also be its beneficiaries.
For the assessment year 2008-09, the trust filed its return declaring income of Rs. 1,81,68,357 and, further, submitted a letter to the A.O. that it had declared the income out of extreme precaution and in good faith to provide complete information and details about the income earned by it but offered to tax by the beneficiaries. It was claimed that the income declared had been included in the return of income of the beneficiaries and offered to tax directly by them pursuant to the provisions of sections 61 to 63 of the Act, which mandated that the income arising from revocable transfers was to be taxed in the hands of the transferors (i.e., the contributors). Accordingly, the Fund had not offered the same to tax again in its hands.
The A.O. was of the view that the individual shares of the persons on whose behalf or for whose benefit the income was received or was receivable by the assessee, or part thereof, were indeterminate or unknown. He was also of the view that the mere fact that the deed mentioned that the share of the beneficiaries would be allocated according to their investments in the Fund, did not make their shares determinate or known. Accordingly, the A.O. invoked the provisions of section 164(1) and held that the assessee would be liable to be assessed at the maximum marginal rate on its whole income. Apart from that, the A.O. also held that the assessee and the beneficiaries joined in a common purpose or common action, the object of which was to produce income, profits and gains, and therefore constituted an AOP. On that count also, the income was brought to tax in the hands of the assessee in the status of an AOP and charged at the maximum marginal rate.
The assessee raised the following contentions before the CIT(A):
1. It should not have been treated as an AOP as there was no inter se arrangement between one contributory / beneficiary and the other contributory / beneficiary, as each of them had entered into separate contribution arrangements with the assessee. Therefore, it could not be said that two or more beneficiaries had joined in a common purpose or common action;
2. The beneficiaries could not be said to be uncertain so long as the trust deed gave the details of the beneficiaries and the description of the person who was to be benefited. Reliance was placed on the CBDT Circular No. 281 dated 22nd September, 1980 wherein it was clarified that it was not necessary that the beneficiary in the relevant previous year should be actually named in the instrument of trust and all that was necessary was that the beneficiary should be identifiable with reference to the instrument of trust on the date of the instrument. With regard to ascertainment of the share of the beneficiaries, it was contended that it was enough if the shares were capable of being determined based on the provisions of the trust deed and it was not the requirement of law that the trust deed should actually prescribe the percentage share of the beneficiary in order for the trust to be determinate. Attention was drawn to the relevant clauses of the trust deed where it was specified who would be the beneficiaries and the formula to determine the share of each beneficiary.
3. The assessee was set up as a revocable trust as the trustees were given power to terminate the trust at any time before the expiry of the term. Therefore, the income of the trust had to be assessed in the hands of the beneficiaries, being the transferors.
The CIT(A) treated the assessee trust as a revocable trust and held that it need not be subjected to tax as the tax obligations had been fully discharged by the beneficiaries of the assessee trust. Aggrieved by the order of the CIT(A), the Revenue preferred an appeal to the Tribunal.
Before the Tribunal, the Revenue, apart from reiterating its stand as contained in the assessment order, drew attention to Circular No. 13/2014 whereby the CBDT had clarified that Alternative Investment Funds which were subject to the SEBI (Alternative Investment Funds) Regulations, 2012 which were not venture capital funds and which were non-charitable trusts where the investors’ name and beneficial interest were not explicitly known on the date of its creation – such information becoming available only when the funds started accepting contribution from the investors – had to be treated as falling within section 164(1) and the fund should be taxed in respect of the income received on behalf of the beneficiaries at the maximum marginal rate. It was claimed that the case of the assessee would fall within the above CBDT Clarifications and therefore the action of the A.O. was correct and had to be restored.
On behalf of the assessee, however, attention was drawn to the clause of the trust deed which contained the following definition:
‘“Contributors” or “Beneficiaries” means the Persons, each of whom have made or agreed to make Contributions to the Trust, in accordance with the Contribution Agreement.’
It was claimed that it was possible to identify the beneficiaries and their share on the basis of the mechanism provided in the trust deed. Reliance was placed on CBDT Circular No. 281 dated 22nd September, 1980 and the decisions in the case of CIT vs. P. Sekar Trust [2010] 321 ITR 305 (Mad); CIT vs. Manilal Bapalal [2010] 321 ITR 322 (Mad); and Companies Incorporated in Mauritius, In re [1997] 224 ITR 473 (AAR). Insofar as the Circular No. 13/2014 relied upon by the Revenue was concerned, it was argued that it was not applicable for the assessment year under consideration and reliance was placed on the decision of the Bombay High Court in the case of BASF (India) Ltd. vs. W. Hasan, CIT [2006] 280 ITR 136 wherein it was held that Circulars not in force in the relevant assessment year cannot be applied.
The assessee also raised the issue of the nature of the trust being revocable and, hence, the income could be assessed only in the hands of the transferors in terms of the provisions of section 61. As far as the status of the trust as an AOP was concerned, the assessee relied upon several decisions including that of the Supreme Court in the case of CIT vs. Indira Balakrishnan [1960] 39 ITR 546 and claimed that the characteristics of an AOP were completely absent in its case.
After considering the contentions of both the parties, the Tribunal inter alia held as follows:
• The trust deed clearly laid down that beneficiaries means the persons, each of whom have made or agreed to make contributions to the trust in accordance with the Contribution Agreement. This clause was sufficient to identify the beneficiaries. It was clarified by Circular No. 281 dated 22nd September, 1980 that it was not necessary that the beneficiary in the relevant previous year should be actually named in the instrument of trust and all that was necessary was that the beneficiary should be identifiable with reference to the order of the instrument of trust on the date of such instrument.
• It was not the requirement of law that the trust deed should actually prescribe the percentage share of the beneficiary in order for the trust to be determinate. It was enough if the shares were capable of being determined based on the provisions of the trust deed. In the case of the assessee, the clause details the formula with respect to the share of each beneficiary and the trustee had no discretion to decide the share of each beneficiary. Reliance was placed on the decision of the AAR in the case of Companies Incorporated in Mauritius, In re (Supra) wherein it was held that the persons as well as the shares must be capable of being definitely pinpointed and ascertained on the date of the trust deed itself without leaving these to be decided upon at a future date by a person other than the author either at his discretion or in a manner not envisaged in the trust deed. Even if the trust deed authorised the addition of further contributors to the trust at different points of time, in addition to the initial contributors, then the same would not make the beneficiaries unknown or their share indeterminate. Even if the scheme of computation of income of beneficiaries was complicated, it was not possible to say that the share income of the beneficiaries could not be determined or known from the trust deed.
• CBDT’s Circular No. 13/2014 dated 28th July, 2014 was not in force in the relevant assessment year for which the assessment was made by the A.O. The Circulars not in force in the relevant A.Y. cannot be applied as held by the Bombay High Court in the case of BASF (India) Ltd. (Supra).
On the basis of the above, the Tribunal held that the income of the assessee trust was determinate; its income could not be taxed at the maximum marginal rate; the income was assessable only in the hands of the beneficiaries as it was a revocable transfer; and that there was no formation of an AOP.
TVS INVESTMENTS IFUND CASE
Thereafter, the issue came up for consideration before the Chennai Bench of the Tribunal in the case of
TVS Investments iFund vs. ITO (2017) 164 ITD 524.
In this case, the assessee was a trust which was formed to receive unit contributions from High Net-Worth Individuals (HNIs) towards the capital amount committed by them as per the terms of Contribution Agreements and provided returns on such investments. For the A.Y. 2009-10, the assessee declared Nil income by treating itself as a representative assessee and claimed that the entire income was taxable in the hands of the beneficiaries. However, the A.O. subjected the entire receipts to tax. He concluded that the assessee was not a Determinate Trust and when not found eligible for deduction u/s 10(23FB) as an alternative investment fund, it could not be extended the benefit of section 164. The ‘pass-through’ status was denied since the assessee was neither a determinate trust nor a non-discretionary trust and therefore the income was taxed in the hands of the representative assessee and not in the hands of the beneficiaries.
In appeal, the CIT(A) held that the assessee trust could not be categorised as a Determinate Trust so as to gain pass-through status. Further, pass-through status was available only when the trust was an approved fund u/s 10(23FB). When the assessee was not a SEBI-approved Alternate Investment Fund, it could not claim pass-through status. The CIT(A) opined that if every trust were to become eligible for pass-through status automatically, then there was no need for an enactment under the Act in the form of 10(23FB) r.w.s. 115U. Accordingly, the CIT(A) dismissed the appeal of the assessee. On being aggrieved, the assessee went in further appeal before the Tribunal.
The Tribunal held that the income of the trust would be chargeable to Maximum Marginal Rate if the trust does not satisfy two tests, i.e., the names of the beneficiaries are specified in the trust deed and the individual shares of the beneficiaries are ascertainable on the date of the trust deed. If the trust has satisfied these tests, then the trust would be treated as a pass-through conduit subject to the provisions of section 160. For getting pass-through treatment the trust should be a determinate and non-discretionary trust. In order to form a determinate trust, the beneficiaries should be known and the individual share of those beneficiaries should be ascertainable as on the date of the trust deed. But in the case under consideration the beneficiaries were not incorporated in the trust deed. The identities of the contributors / beneficiaries were unknown. The investment manager gathered the funds from the contributors and the benefit was passed on to the contributors based on the proportion of their investments in the assessee trust. The exception to this rule, and providing pass-through status to a Trust, even though the contributing beneficiaries were not mentioned in the deed of trust, was only extended to AIF(VCF) which were registered with SEBI and eligible for exemption u/s 10(23FB) r.w.s. 115U.
The Tribunal distinguished the decision of the Madras High Court in the case of CIT vs. P. Sekar Trust [2010] 321 ITR 305 which was relied upon by the assessee on the ground that in that case the beneficiaries were incorporated on the day of institution of the trust deed and, moreover, they did not receive any income in that year. Further, the individual share of the beneficiaries was also ascertainable on the date of the trust. As against this, in the assessee’s case neither the names of the beneficiaries were specified in the trust deed nor were the individual shares of the beneficiaries ascertainable on the date of the institution of the trust. Therefore, the Tribunal upheld the order of the A.O. taxing the income of the assessee trust at the maximum marginal rate under the provisions of section 164(1).
OBSERVATIONS
The taxation of discretionary trusts at maximum marginal rate was introduced in section 164(1) by the Finance Act, 1970 with effect from 1st April, 1970. The objective behind its introduction was explained in Circular No. 45 dated 2nd September, 1970 which is reproduced below:
Private discretionary trusts. – Under the provisions of s. 164 of the IT Act before the amendment made by the Finance Act, 1970, income of a trust in which the shares of the beneficiaries are indeterminate or unknown, is chargeable to tax as a single unit treating it as the total income of an AOP. This provision affords scope for reduction of tax liability by transferring property to trustees and vesting discretion in them to accumulate the income or apply it for the benefit of any one or more of the beneficiaries, at their choice. By creating a multiplicity of such trusts, each one of which derives a comparatively low income, the incidence of tax on the income from property transferred to the several trusts is maintained at a low level. In such arrangements, it is often found that one or more of the beneficiaries of the trust are persons having high personal incomes, but no part of the trust income being specifically allocable to such beneficiaries under the terms of the trust, such income cannot be subject to tax at a high personal rate which would have been applicable if their shares had been determinate.
Thus, it can be seen that the objective was to curb the practice of forming multiple trusts, whereby each of them derived minimum income, so that it did not fall within the higher tax bracket.
Thereafter, the Explanation was added by the Finance (No. 2) Act, 1980 with effect from 1st April, 1980 deeming that, in certain situations, beneficiaries shall be deemed to be not identifiable or their shares shall be deemed to be unascertained or indeterminate or unknown. The legislative intent behind insertion of this Explanation has been explained in the Circular No. 281 dated 22nd September, 1980 which is reproduced below:
Under the provisions as they existed prior to the amendments made by the Finance Act, the flat rate of 65 per cent was not applicable where the beneficiaries and their shares are known in the previous year although such beneficiaries or their shares have not been specified in the relevant instrument of trust, order of the court or wakf deed. This provision was misused in some cases by giving discretion to the trustees to decide the allocation of income every year and in several other ways. In such a situation, the trustees and beneficiaries were able to manipulate the arrangements in such a manner that a discretionary trust was converted into a specific trust whenever it suited them tax-wise. In order to prevent such manipulation, the Finance Act has inserted Explanation 1 in section 164 to provide as under:
a. any income in respect of which the court of wards, the administrator-general, the official trustee, receiver, manager, trustee or mutawalli appointed under a wakf deed is liable as a representative assessee or any part thereof shall be regarded as not being specifically receivable on behalf or for the benefit of any one person unless the person on whose behalf or for whose benefit such income or such part thereof is receivable during the previous year is expressly stated in the order of the court or the instrument of trust or wakf deed, as the case may be, and is identifiable as such on the date of such order, instrument or deed. [For this purpose, it is not necessary that the beneficiary in the relevant previous year should be actually named in the order of the court or the instrument of trust or wakf deed, all that is necessary is that the beneficiary should be identifiable with reference to the order of the court or the instrument of trust or wakf deed on the date of such order, instrument or deed;]
b. the individual shares of the persons on whose behalf or for whose benefit such income or part thereof is receivable will be regarded as indeterminate or unknown unless the individual shares of such persons are expressly stated in the order of the court or the instrument of trust or wakf deed, as the case may be, and are ascertainable as such on the date of such order, instrument or deed.
As a result of the insertion of the above Explanation, trust under which a discretion is given to the trustee to decide the allocation of the income every year or a right is given to the beneficiary to exercise the option to receive the income or not each year will all be regarded as discretionary trusts and assessed accordingly.
The following points emerge from a combined reading of both the Circulars, clarifying the objective behind amending the provisions of section 164(1) to provide for taxability of discretionary trusts at the maximum marginal rate and inserting the Explanation providing for deemed cases of discretionary trust:
• There was a need to tax the income of the discretionary trusts at the maximum marginal rate to curb the practice of creating multiple trusts and thereby avoiding tax by ensuring that they earn low income, so that they do not get taxed at the maximum marginal rate.
• To overcome this issue, the provisions of section 164(1) were amended to provide that the income of the discretionary trust (where the beneficiaries or their share are not known or determinate) is liable to tax at the maximum marginal rate.
• Even after providing for taxability of such discretionary trusts at the maximum marginal rate in section 164(1), the practice of avoiding it continued in some cases, as there was no requirement under the law that the beneficiaries or their shares should have been specified in the relevant instrument of trust, order of the court or wakf deed.
• Although the discretion was given to the trustees to decide the allocation of income every year, the affairs of the trusts were so arranged whereby it was claimed that the beneficiaries and their shares were known in the concerned previous year and, therefore, the provisions of section 164(1) were not applicable to that previous year.
• To plug this loophole, the Explanation was inserted to provide that the beneficiaries and their shares should be expressly stated in the relevant instrument of trust, order of the court or wakf deed.
• It has been expressly clarified that it is not necessary that the beneficiary in the relevant previous year should be actually named in the order of the court or the instrument of trust or wakf deed and all that is necessary is that the beneficiary should be identifiable with reference to the order of the court or the instrument of trust or wakf deed on the date of such order, instrument or deed.
• Only cases where a discretion is given to the trustee to decide the allocation of the income every year or a right is given to the beneficiary to exercise the option to receive the income or not each year will be regarded as discretionary trusts and assessed accordingly.
In the background of these legislative developments, it can be inferred that the requirement is not to name the beneficiaries in the instrument of trust but to provide for the identification of the beneficiaries on an objective basis. This has been made expressly clear in the aforesaid Circular itself. These aspects had not been pointed out to the Chennai Bench of the Tribunal in the case of TVS Investments iFund (Supra). The Bengaluru Bench of the Tribunal considered the legislative intent and the aforesaid Circulars to hold that it would be sufficient if the trust deed provided that the contributors would be beneficiaries and further it provided for the formula to arrive at the individual share of each beneficiary.
It may be noted that both the above decisions of the Tribunal had been challenged before the respective High Courts. The Revenue had filed an appeal before the Karnataka High Court against the decision of the Bengaluru Bench in the case of India Advantage Fund (Supra). Before the High Court it was contended on behalf of the Revenue that the exact amount of share of the beneficiaries and its quantification should have been possible on the date when the trust deed was executed or the trust was formed. If such conditions were not satisfied, then the shares of the beneficiaries would turn into non-determinable shares. The High Court rejected this argument by holding as under:
10. In our view, the contention is wholly misconceived for three reasons. One is that by no interpretative process the Explanation to section 164 of the Act, which is pressed in service can be read for determinability of the shares of the beneficiary with the quantum on the date when the Trust deed is executed, and the second reason is that the real test is the determinability of the shares of the beneficiary and is not dependent upon the date on which the trust deed was executed if one is to connect the same with the quantum. The real test is whether shares are determinable even when or after the Trust is formed or may be in future when the Trust is in existence. In the facts of the present case, even the assessing authority found that the beneficiaries are to share the benefit as per their investment made or to say in other words, in proportion to the investment made. Once the benefits are to be shared by the beneficiaries in proportion to the investment made, any person with reasonable prudence would reach to the conclusion that the shares are determinable. Once the shares are determinable amongst the beneficiaries, it would meet with the requirement of the law, to come out from the applicability of section 164 of the Act.
11. Under the circumstances, we cannot accept the contention of the Revenue that the shares were non-determinable or the view taken by the Tribunal is perverse. On the contrary, we do find that the view taken by the Tribunal is correct and would not call for interference so far as determinability of the shares of the beneficiaries is concerned.
12. Once the shares of the beneficiaries are found to be determinable, the income is to be taxed of that respective sharer or the beneficiaries in the hands of the beneficiary and not in the hands of the trustees which has already been shown in the present case.
Thus, the view of the Bengaluru Bench of the Tribunal was affirmed by the Karnataka High Court.
The decision of the Chennai Bench of the Tribunal in the case of TVS Investments iFund (Supra) was challenged by the assessee before the Madras High Court. Before deciding the issue, the Madras High Court had already dealt with it in the case of CIT vs. TVS Shriram Growth Fund [2020] 121 taxmann.com 238 and decided it in favour of the assessee by relying on its own decision in the case of CIT vs. P. Sekar Trust [2010] 321 ITR 305 (Mad). It was noted by the Madras High Court that the Chennai Bench had wrongly disregarded the decision in the case of the P. Sekar Trust. The relevant observations are reproduced below:
In fact, the Tribunal ought to have followed the decision of the Division Bench of this Court in the case of P. Sekar Trust (Supra). However, the same has been distinguished by the Tribunal in the case of TVS Investments iFund (Supra) by observing that the said judgment is not applicable to the facts of the case because in it, the beneficiaries are incorporated on the day of the institution of the Trust Deed and, moreover, they did not receive any income in that year. Unfortunately, the Tribunal in the case of TVS Investments iFund (Supra), did not fully appreciate the finding rendered by the Hon’ble Division Bench of this Court and post a wrong question, which led to a wrong answer.
The Madras High Court in this case concurred with the view of the Karnataka High Court in the case of India Advantage Fund (Supra) and decided the issue against the Revenue. The same view was then followed by the Madras High Court in the case of TVS Investments iFund and overruled the decision of the Chennai Bench of the Tribunal.
A similar view had been taken by the Authority for Advance Rulings in the case of Companies Incorporated in Mauritius, In re (Supra).
The better view of the matter therefore is the view taken by the Bengaluru Bench of the Tribunal in the case of India Advantage Fund, as affirmed by the Karnataka and Madras High Courts, that it is not necessary to list out the beneficiaries and their exact share in terms of percentage in the trust deed. It is sufficient if the trust deed provides both for the manner of identification of the beneficiaries as well as a mechanism to compute their respective shares in the income of the trust for any year, without leaving it to the discretion of the trustee or any other person.
