Trusts — do they help save tax?

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The suggestion to create many trusts for a single beneficiary overlooks Sec. 164(1) as the department has the option to assess the trust or the beneficiary.

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Tax Forum has not been highlighting the advantage of private trusts for tax savings. I understand that a person can create more than one trust for the same beneficiary, each trust having income less than Rs. 1 lakh, so that there is no liability to tax on such income of each such trust. I am also advised that a trust created for the benefit of a minor beyond his minority will avoid tax because it cannot be taxed in the year of income, since he has no right to enjoy the income during the year. When he has the right to receive the same on attainment of majority, such amount will not be taxable, because it will be a capital receipt. You may advise me on the merits of forming such ongoing trusts, as a method of tax planning suggested by some tax advisors.

A trust for the benefit of a minor with the right to enjoyment of the income only after he attains majority had become popular, because of the decision of the Supreme Court in CIT v M. R. Doshi (1995) 211 ITR 1 (SC). It was held in this case that since the minor was not in a position to enjoy the income, such income could not be clubbed with that of the parent — clubbing was required if the income was from assets transferred by such parent. Now that there is automatic aggregation, the applicability of this law itself may be doubtful. Even taking it for granted that it cannot be so clubbed under the present law as well, the income does not escape taxation as wrongly assumed in the query. The accumulated income distributed on termination of the trust on the minor attaining majority is still income, though bunched, so that it cannot avoid tax at the time when the minor becomes entitled to it. The view that such bunched income will be a capital receipt is mistaken. The Supreme Court has held that the erstwhile minor will be assessable in the year when the right to receive the same arises as held in CIT v Kamalini Khatau (1994) 209 ITR 101 (SC) and Moti Trust v CIT (1999) 236 ITR 37 (SC).

However, the Income-tax Department need not wait for taxing such amount till the beneficiary of such a trust attains majority, because these decisions have application only where direct assessment on the erstwhile minor is sought to be made on his income. Sec. 161 of the Income-tax Act provides for assessment of the trustee as a representative assessee "in like manner and to the same extent". The trust can be assessed as and when the income arises. If it is so done, M. R. Doshi's case (supra) would have no application as was found by the Gujarat High Court in Ganesh Chhababhai Vallabhai Patel v CIT (2002) 258 ITR 193 (Guj). The Bangalore bench of the Income-tax Appellate Tribunal even without the benefit of the Gujarat High Court decision found that where direct assessment is not possible, the income has necessarily to be assessed under Sec. 164(1) in the hands of the trust/ trustee in ITO v Sheetal Sundar Trust (2005) 279 ITR (AT) 183 (Bangalore). In fact, it was also held that in view of the contingency of the beneficiary not surviving on the date of maturity of the trust, tax might be levied at the maximum marginal rate. It may therefore be seen that the creation of a trust for the benefit of a minor with postponement of right to enjoyment beyond the period of minority will unnecessarily lock up the funds or assets with no tax benefit as has been suggested. On the contrary, there is a possibility of a larger tax liability.

The other suggestion to create many trusts for the same beneficiary again overlooks Sec. 164(1) which gives an option to the department either to make an assessment on the trust or the beneficiary. A direct assessment is a normal assessment, where the assessee has to include the benefits, if any, from trusts. In fact, the department is bound to assess the beneficiary directly in such cases so as to ensure that legitimate tax is properly collected. The authorities can also ignore the creation of so many trusts for the same beneficiary unless they are for different purposes or otherwise justified for any purpose other than mere tax saving. Here again, such trusts will unnecessarily lock up funds for certain assumed advantage.

Probably such trusts continue to be formed as mentioned in the query because revenue is not vigilant enough and will accept such returns on these wrong assumptions at face value without considering the alternative liability expected to be enforced in law. But then, this lack of vigilance on the part of the department may be temporary and it will not therefore be sound tax planning as wrongly assumed in the query.

Source : www.hinduonnet.com Published on : 27.02.2006