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Sunday, August 20, 2000













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Taxation of discretionary trust

T. Banusekar

THIS column dated July 16, carried an article, ``Private Trusts -- concept, taxability and planning''. It stated that a private trust might be divided into an oral trust or written trust. A written trust further being subdivided into a specific trust and a discretionary trust. It also discussed the manner of taxation of an oral trust and a specific trust.

A discretionary trust is a trust in which the individual shares in income or corpus of the beneficiaries are indeterminate or unknown. As a general rule such trusts are taxed at the maximum marginal rate (MMR). This rule is however subject to certain exceptions (for the exact manner of taxability of discretionary trust, see table).

Where the terms of trust deed prescribe the shares of the beneficiaries in respect of income but not in respect of the corpus, the trust will still be a discretionary one.

Where a person has contingent interest in the accumulation and does not hold the paid interest until the contingency arises, there shall be no question of his/her share arising. A person may have vested interest, which is defeasible under certain circumstances such as the birth of a child. Insofar as the income of the beneficiary having a contingent interest is concerned, the share is indeterminate and unknown for no share can possibly be determined until the contingency happens. It will therefore be a discretionary trust.

It would suffice if the trust deed has got certain recitals with the help of which the shares of the beneficiaries at any given point of time can be ascertained. The mere fact that the trust deed provides for certain contingencies (such as marriage and death) which will change the beneficial interest, does not by itself make the beneficiaries and their interest indeterminate so as to make the trust discretionary.

The mere fact that the computation of beneficiary's share in income is complicated does not mean the shares are indeterminate or unknown if it is possible to ascertain (though with difficulty) shares of the beneficiaries. The trust would still be specific.

Where a trust is created for the benefit of a would be daughter-in-law or would be son-in-law and where the trust deed provides that the intended marriage, if it did not take place within a stipulated period, the trust property would revest in the settler, then it can be said that the beneficiaries are known and determinate. Thus, this will be a specific trust.

Where the trustees of a discretionary trust are assessed in the status of an individual, the deductions under Section 80L will be available.

Where tax is levied at MMR, the basic exemption is not available.

Where the trust is a specific trust and where the trustee is chargeable in a like manner and to the same extent as the beneficiary, all deductions and rebates including rebate under new section 88C will be available in computing income and tax.

Where a trustee is assessed as a specific trust in a like manner and to the same extent as the beneficiaries, the trustee can claim the exemption under Section 54.

While computing if the income of any of the beneficiaries exceeds the maximum amount not chargeable to tax, the share from the trust should not be taken in to account.

Where a trust is taxed at the rates applicable to an individual, the share income from such trust shall be included in the hands of the beneficiary for rate purposes.

Where a trust is taxed at MMR or at a higher rate, share income from the trust is not be included in the hands of the beneficiary either for computing tax liability of the beneficiary or for rate purposes.

Tax planning

W Where a trust is created for the deferred benefit of a minor child, by accumulating the income of the trust until such time as the minor attains majority, the provisions relating to clubbing under Section 64 (1A) will not be attracted.

Multiple trusts may be created for the benefit of the same person but for different purposes. If each of these trusts are taxed in the like manner and to the same extent as the beneficiary, it may be possible that the basic exemption will be available, as many times as there are trusts. this will also apply to deductions and rebates.

Where a transfer is made by an individual to his daughter-in-law to be, who is already identified, through a trust, the provisions relating to clubbing under Section 64(1) shall not be attracted. If the individual is also the trustee himself, it may be possible to exercise control without attracting the clubbing provisions.

Where business is conducted by a trust, it will stand to benefit if the business is transferred by way of will, provided the trust is for the benefit of any relative who is dependent on the author for support and maintenance and if that is the only trust declared by him. This is so because in such a case, income may not be taxed at MMR.

Care must be exercised in the case of a discretionary trust to see that the income of none of the beneficiaries exceeds the maximum amount not chargeable to tax, so that the exception to the taxability of the discretionary trust may be applicable.

Where the income of any of the beneficiaries excluding the share from the trust is likely to exceed the maximum amount not chargeable to tax, it may be possible to change the beneficiaries by reducing or increasing the number of beneficiaries. Such power is to be given to the trustees by the instrument of trust. The trustees will be bound to perform the obligation cast on them through the deed of trust and therefore the trust will not be assessed at MMR.

It would be advisable while drafting the trust deed to provide for terminating the trust by accelerating the date of distribution of the corpus by the trustees to the beneficiaries. This should be provided for in case of contingencies, so that when it becomes unwise, (from the tax point of view) the trust can be wound up.

(The author is a Chennai-based practising chartered accountant.)

Business Line invites queries on personal taxation issues to this column. They will be answered in the first Sunday's issue of Business Line every month. Queries may be addressed to Tax Talk, Business Line, Kasturi Buildings, 859, Anna Salai, Chennai 600 002, or by e-mail to rags@thehindu.co.in


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