The Indian Trust Act, 1882, governs a Private Trust. Private trust is a vehicle through which property can be transferred from one person (owner) to another for the benefit of an individual or an ascertainable group of people.

A private trust is created for the benefit of specific individuals i.e., individuals who are defined and ascertained individuals or who within a definite time can be definitely ascertained. A family trust set up to benefit members of a family is the most common purpose for a private trust. The purpose of the family trust is for the settlor to progressively transfer his assets to the trust, so that legally the settlor owns no assets himself, but through the trust, beneficiaries get the benefit of these assets.

Private trusts can act an effective estate planning tool if you have a special child, a large business to be transferred to the next generation or a large estate to protect. Although the formation of a private trust resolves many issues, a lot needs to be considered in making a private trust, especially from the taxation point of view. As the income of a trust is taxed differently in different structures, careful planning is required to reap benefits without draining much money in the form of income-tax.

As the income of a private trust is available only to the beneficiaries, taxation is carried out according to the structure in which the income has been received. 

From tax point of view, there are two structures under which the income of a private trust is taxed:

Specific trust: Here the income is received by the representative assesses on behalf of a single beneficiary. As the individual share of the beneficiary is known, taxation is done accordingly. For instance, it should be clearly stated in the trust deed that XYZ would get 50 per cent of the total income of the trust or the author’s son will draw the entire benefits from the trust.

Discretionary trust: With more than one beneficiaries, the individual shares are not known. Here the income of the trust is not received by a representative but determined by the trustees.

Taxability of Private Specific/Determinate Trust.

1. Status of the Trust –would take the same status as the beneficiaries to the extent of their share
2. Residential status of the Trust –would take the same status as the beneficiaries to the extent of their share
3. Taxability in the hands of the Trustee or beneficiary? –in so far as the private non-discretionary trust is concerned, the shares of the real owners of the income i.e. the beneficiaries is known and therefore, the income can be taxed either in the hands of the beneficiaries directly or in the hands of the trustees in their capacity of representative assessee. However, there would be no double taxation. This has been clarified by the Board in Circular No. 157 dt. 26.12.1974.
4. Taxability in the hands of the trustee – in a representative capacity u/s 161(1) r.w.s. 160 of the Act. Tax 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.

The Supreme Court in case of Nizams (supra) has held that

“It is also necessary to notice the consequences that seem to flow from the proposition laid down in s. 21, sub-s. (1), that the trustee is assessable” in the like manner and to the same extent “as the beneficiary. The consequences are three-fold. In the first place, it follows inevitably from this proposition that there would have to be as many assessments on the trustee as there are beneficiaries with determinate and known shares, though, for the sake of convenience, there may be only one assessment order specifying separately the tax due in respect of the wealth of each beneficiary. Secondly, the assessment of the trustee would have to be made in the same status as that of the beneficiary whose interest is sought to be taxed in the hands of the trustee….And, lastly, the amount of tax payable by the trustee would be the same as that payable by each beneficiary in respect of his beneficial interest, if he were assessed directly.”

5. Benefits available –All the benefits, deductions or allowances which an individual beneficiary could have obtained are also available to the trustees assessed in representative capacity– for instance benefit u/s 54 of the Act. (See 237 ITR 82 (Bom) Mrs. Amy P. Cama, Trustee of the Estate of Late M. R. Adenwalla v. CIT)
6. Rate of tax –If taxable in hands of the beneficiaries then the normal rates applicable to the beneficiaries. Similar position to apply even if tax recovered from the Trustee in representative capacity. Section 161(1A) states that, where the income consists of any profits or gains of business, then the same is to be taxed at MMR, subject to certain exception. Further, special rates as are applicable to special category of income like long term capital gain would continue to apply. [See in favour – Mahindra & Mahindra Employees’ Stock Option Trust [2015] 44 ITR(T) 658 (Mumbai – Trib.), Jamsetji Tata Trust v. JCIT [2014] 148 ITD 388 (Mumbai – Trib.). Against – DCIT v. India Cements Educational Society [2016] 46 ITR(T) 80 (Chennai – Trib.) and Companies Incorporated in Mauritius, In re [1997] 224 ITR 473 (AAR)]

Taxability of Private Discretionary Trust.

1. Status of the Trust –would take the same status as the beneficiaries since the representative assessee has to be taxed in the like manner and to the same extent as per section 161 [See the judgment of the Apex Court in case of CIT v. Smt. Kamalini Khatau – 209 ITR 101(SC)]. Therefore, if all the beneficiary are of same status i.e. either individual or company etc. then the trustees would take the same status.

However, if the beneficiaries are carrying different status, then the status of the trustees cannot be determined. In such cases, the Courts have held that the trustees should be taken an assessable unit liable to be taxed as an individual (as discussed above).

Proviso to section 164(1) states that, in certain cases tax would be leviable as if it were the total income of an AOP. Proviso to section 164(1) only lays down that the rate of AOP would apply and it cannot be inferred therefrom that the trust would be considered as an AOP.

2. Residential status of the Trust –would take the same status as the beneficiaries. If all are resident, the Trustees would be treated as a resident and vice versa. However, in case where some of the beneficiaries are resident and some are not, then determination of the residential status of the trustees is a grey area with no reasonable certainty. Though there are opinions to the effect that the residential status of the trustees would be taken into consideration, however, there is no or less legal backing.
3. Taxability in the hands of the Trustee or beneficiary –

In so far as the private non-discretionary trust is concerned, the shares of the real owners of the income i.e. the beneficiaries is not known. Where the income of the trust accruing in a particular year is not distributed amongst the beneficiaries, one would not be aware about the income of any particular beneficiary. In such a case, the tax has to be paid by the trustee in representative capacity u/s 164(1).

In case where the income has been distributed to the beneficiaries, tax can be recovered from the trustee u/s 164(1). Further, in such cases, the Courts have held that the tax can be recovered from the beneficiaries also.

However, as already specified earlier there cannot be any double taxation.

4. Taxability in the hands of the trustee –in a representative capacity u/s 161(1) r.w.s. 160 of the Act. Tax 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. 
5. Benefits available – it will be difficult to argue that all the benefits available to the individual would be available to the trustee, unless any specific condition to claim the deduction etc. has been fulfilled on behalf of any specific beneficiary. However, since the trustee would be assessable as individual, all benefits so available to an individual would be available to the trustee.
6. Rate of tax –

Section 164(1) states that the income of an indeterminate trust would be taxable at MMR. Though it uses the word ‘charge’, section 164 does not create a charge [See Kamalini Khatau (supra)].

Proviso, to section 164(1) provides for exceptions to the above rate of MMR and in case of such exceptions, the rate applicable to AOP would apply.

If tax is recovered from the beneficiaries, it is doubtful whether the rates as applicable to the beneficiaries would apply or whether MMR would apply in accordance with section 164(1).

Further, section 161(1A) which provides for taxation of business income at MMR, would equally apply in case of indeterminate trust.

Also, as discussed earlier, special rates as are applicable to special income like long term capital gain would continue to apply.

Key Points