TAXABILITY OF PRIVATE TRUST’S INCOME – SOME ISSUES

SPECIFIC TRUST VS. DISCRETIONARY TRUST

a) There must be as many assessments on the trustees as there are beneficiaries with determinate and known shares, though for the sake of convenience there may be one assessment order specifying separately the tax due in respect of the income of each of the beneficiaries;
b) The assessment of the trustees must be made in the same status as that of the particular beneficiary whose income is sought to be taxed in the hands of the trustee; and
c) The amount of tax payable by the trustees must be the same as that payable by each beneficiary in respect of the share of his income, if he were to be assessed directly.

Thus, it is clear that income in case of specific trust cannot be taxed in the hands of the trustees as one unit u/s 161(1) and tax on the share of each beneficiary shall be computed separately as if it formed part of the beneficiaries’ income. It is because of this reason that the Madras High Court in the case of A.K.A.S. Trust vs. State of Tamil Nadu, 113 ITR 66, held that a single assessment on the trustees by clubbing the income of all beneficiaries whose shares were defined and determined was not valid.

As opposed to specific trust there is a discretionary trust which means that the trustees have absolute discretion to apply the income and capital of the trust and where no right is given to the beneficiary to any part of the income of the trust property. Section 164 of the Act itself provides that a discretionary trust is a trust whose income is not specifically receivable on behalf of or for the benefit of any one person, or wherein the individual shares of the beneficiaries are indeterminate or unknown.

Therefore, section 161(1) can apply only where income is specifically received or receivable by the representative assessee on behalf of or for the benefit of the single beneficiary, or where there are more than one, the individual shares of the beneficiaries are defined and known. Tax in such a case would be levied on the representative assessee on the portion of the income to which any particular beneficiary is entitled and that, too, in respect of such portion of income. On the other hand, if income is not receivable or received by the representative assessee specifically on behalf of or for the benefit of the single beneficiary, or where the beneficiaries being more than one, their shares are indeterminate or unknown, the assessment on the representative assessee qua such income would be in accordance with the provision of section 164.

APPLICABILITY OF MAXIMUM MARGINAL RATE

‘Now reverting to section 161(1A) of the Act it must be noted the sub-section (1A) only says, “notwithstanding anything contained in sub-section (1)”: in other words, it does not say “notwithstanding anything contained in this Act”. Thus, though the provisions of sub-section (1A) override the provisions of sub-section (1) of section 161, it does not have the effect of overriding the provisions of section 26 of the Act and consequently computation of the income from house property has to be made under sections 22 to 25 of the Act since the Tribunal had entered a categorical finding that the shares of the beneficiaries are definite. As already noted, as per sub-section (1A), where any income in respect of which a representative assessee is liable consists of, or includes, income by way of profits or gains of business, tax shall be charged on the whole of the income in respect of which such person is so liable at the maximum rate. The income so liable referred to in the said sub-section is only the business income of the trust and not any other income. It is only the income by way of profits and gains of business that can be charged at the maximum marginal rate. Any other interpretation, according to us, is against the very scheme of the Act and further such an interpretation will make the provisions of sub-section (1A) of section 161 unconstitutional. It is a well settled position that if two constructions of a statute are possible, one of which would make it intra vires and the other ultra vires, the Court must lean to that construction which would make the operation of the section intra vires (Johri Mal vs. Director of Consolidation of Holdings, AIR 1967 SC 1568).

This was an important interpretation placed by the Kerala High Court which is available to the taxpayers and can be pressed in appropriate cases.

According to section 164(1), income of the discretionary trust shall suffer tax at the maximum marginal rate, meaning that there would not be any basic exemption available except in situations provided under the provisos appended thereto. However, the Gujarat High Court in Niti Trust vs. CIT 221 ITR 435 (Guj.) has held that if there is a long-term capital gain, the maximum marginal rate applicable is 20% and such income would suffer the tax @ 20%. A similar position has been explained and taken by the Mumbai Bench of the Income-tax Appellate Tribunal in the case of Jamshetji Tata Trust vs. JDIT (Exemption) 148 ITD 388 (Mum.) and in Mahindra & Mahindra Employees’ Stock Option Trust vs. Additional CIT 155 ITD 1046 (Mum).

It may, however, be noted that the maximum marginal rate (MMR) as per the existing tax structure otherwise would work out to approximately 42.74%. Therefore, it can be taken in case of discretionary trust that if income includes any income on which special tax rate is applicable, that special rate being MMR for that income would be applicable qua such income and the rest of the income would suffer the tax rate (MMR) of 42.74% approximately.

‘ON BEHALF OF’ ‘FOR THE BENEFIT OF’

The Supreme Court in the case of W.O. Holdswords & Ors. vs. State of Uttar Pradesh, 33 ITR 472, had occasion to examine both the phrases in the context of the position of trustees. The Court held that trustees do not hold the land from which agricultural income is derived on behalf of the beneficiary but they hold it in their own right though for the benefit of the beneficiary. Besides, a trust is defined in the English Law as ‘A trust in the modern and confined sense of the word is the confidence reposed in a person with respect to property of which he has possession or over which he can exercise a power to the intent that he may hold the property or exercise the power for the benefit of some other person or objects’ (vide Halsbury’s Laws of England, Hailsham Edition, Volume 33, page 87, para 140).

Thus, it is more than evident that legal estate is vested in the trustees who hold it for the benefit of the beneficiary. Section 3 of the Indian Trust Act, 1882 is also clear and categorical on this point to the effect that the trustees hold the trust property for the benefit of the beneficiaries but not ‘on their behalf’.

Section 56(2)(x) introduced by the Finance Act, 2017 provides inter alia that any sum of money and / or property received by a person without consideration, or property received by a person without adequate consideration, would constitute income. There is some threshold limit in certain situations given under that section but that is not relevant for the purpose of the present discussion. Exceptions given in the proviso to section 56(2)(x) provide inter alia that money or property received from an individual by a trust created or established solely for the benefit of a relative of an individual would not be hit by clause (x) of section 56(2). Thus, if the settlor is an individual and the beneficiary is a relative of such individual, receipt of money and / or property by the trustees for the benefit of the relative would not be hit by the provisions of section 56(2)(x).

But whether the property settled by the individual settlor for the benefit of a non-relative would become taxable income u/s 56(2)(x) is a question which would engage all of us.

Section 4, which is the charging section, provides inter alia that income tax shall be charged for any assessment year in accordance with and subject to the provisions of the Act in respect of total income of the previous year of every person. Section 5 provides inter alia that total income of any previous year of a person includes all income from whatever source derived which is received or deemed to be received in India in such year by or on behalf of such person. Therefore, any income which is not received by the person or on behalf of such person cannot be brought within the scope of total income. In other words, income received for the benefit of such person is not contemplated to be covered u/s 5 and cannot be brought to tax in the hands of such person. Therefore, when the trustees receive the property for the benefit of the beneficiary, such receipt falls outside the scope of total income even if the beneficiary is a non-relative qua the settlor as the receipt of the property by the trustees cannot be said to be received by the beneficiary or received on behalf of the beneficiary. Therefore, the applicability of section 56(2)(x) even in the case of a non-relative beneficiary in the light of the above interpretation may not be easy for the Revenue. However, such interpretation is liable to be fraught with strong possibility of litigation.

In sum, taxability of private trust has been saddled with lots of controversies many of which have been sought to be given quietus with amendments made from time to time, but such controversies are never-ending.