Private Trust in India & their Taxation – Why should you consider them?

Private trust in India is an effective estate planning & tax planning tool. This is a detailed article, will cover What are Private Trusts?, Why Private Trust in India?, benefits & limitations, Trust Vs Will, Private Trust Taxation in India, You can also check a presentation on Trust & WILLs by our member. I think after reading this post all your questions will be answered – also check 150 comments below this post.

Private Trust in India

Rahul has been running a business for the last ten years. He has two children – four and six years of age. Rahul has been worrying about – What will happen to them after him? How will I ensure that their expenses are met? Who will run my business after me? All these thoughts are bothering him while planning for his own future.

Situations like Rahul are common. In fact, most of us make the mistake by not taking proper steps in protecting our assets and transferring them to our children. The biggest problem comes when there is a premature death and children are not old enough to take care of themselves.

Although a Will can be written for transferring the assets, it still has some limitations and cannot be the only mode of bequeathing one’s assets among the beneficiaries, especially in cases like Rahul. Creating a Private Trust resolves most of the problems and can be beneficial in the management and distribution of assets.

Private Trusts, Public Trusts & Wills Presentation

Trusts and wills India from The Financial Planners’ Guild India

Private Trusts Meaning

The primary objective of any individual who wants to bequeath his assets during the lifetime or after death is to protect the interest of beneficiaries. The beneficiaries might include minors who are not old enough to protect their interests. A trust creation helps in meeting this objective. When there are one or more individuals like family members as beneficiaries, a private trust is formed. The trust can be created by any person who is a major and is capable of entering into a contract.

Read – Estate Planning Basics

Benefits of private trust in India

While managing property during one’s lifetime, there are various risks which arise and need to be addressed. There may be old parents living separately far away from their children and the children are still minors while the parents have reached old age. During succession planning the concerns could be, care for the spouse and children and donation to charity etc.  All these scenarios demand the formation of a Private Trust whose main objective is to manage property (movable and immovable) at present and in future when primary bread-earner is not around. NRI Gift Tax India

Who benefits from a Trust?

Creation of a Private Trust can be very helpful for different family situations and businesses:

  1. Nuclear and joint families: For a nuclear family, separation, legal hurdles, old age medical care, child’s future and financial security are concerns around which the whole life revolves. Contrary to this in a joint family there have been instances of family litigations leading to business interruptions and assets getting locked in legal battles for years. Many of these issues can be addressed through a private trust.
  2. Entrepreneur: An entrepreneur starts his business with a dream to grow big in the future. During the course he has to ensure his personal and business assets are clearly defined. Sometimes, a claim can arise from any of his client’s and the business gets disrupted if the solution is prolonged. By forming a trust the continuity of business and distinction between the assets can be taken care off.
  3. Family of a special child: They are the biggest beneficiaries of creating a private trust. A special child needs are regular medical assistance, financial support when parents are not around, preservation of wealth. By creating a trust, parents can make sure that above requirements get fulfilled in a very efficient manner.
  4. Muslims: Although Muslim laws are slightly different when formation of trust is concerned, the objective remains same for them.

There can be many other situations where formation of a private trust can help in securing present and future of your loved ones according to your wishes.

Limitations of Private Trust

Although formation of a private trust can benefit a large number of families and in different situations, it has some limitations which should be taken into consideration while planning;

  1. Cost: During transfer of immovable assets, stamp duty is paid as per the rate prevailing in the State. Due to this variation, cost of formation of a trust also varies across states.
  2. Trustees: Efficiency of a trust is highly dependent on the selection of the trustees. The trustees are to be appointed by the settlor. A wrong selection can defeat the objective of forming a trust.
  3. Trust deed: Drafting a trust deed is more difficult than a Will. If not drafted clearly, a trust deed is difficult to execute.

Trust vs. Will

In many instances a written Will is insufficient to distribute your assets. The battle fought in courts in various cases has revealed that a Will has its own limitations. Below are some benefits which makes creating a private trust more beneficial than just writing a Will:

  • Since a trust deed is never disclosed in media, it is more confidential than a will.
  • There is no probate when you create a trust.
  • When you want to make some changes in future a trust deed can be easily modified in comparison to a Will.
  • While planning for succession, especially during one’s lifetime, one would not want to lose control over the assets. This can be achieved efficiently through a private trust as a Will gets executed only after the death.

Creating a private trust is more beneficial than just writing a Will, but it all depends on the amount of assets one has and how you want to bequeath your property. A Will gets effective only after your demise while a trust can still be run even when you are around. To ensure your trust runs efficiently do remember following points while creating it:

  1. Lay down your long term objectives very clearly. It will help the trust to accommodate any changes later.
  2. To make your trust more efficient, make sure the trustees you decide have the skill and experience necessary for their prescribed tasks.
  3. Identify clearly who will be your beneficiaries to avoid any dissatisfaction later.
  4. Identify the list of assets which you want to include during your lifetime and in future when you are not around.

Private Trust Taxation in India

A private trust in India is an effective estate planning tool. Whether you have a special child, an estate to protect, or a business to be transferred to next generation, formation of a private trust resolves many issues in such situations. Although there is a lot of consideration before a private trust can be created one very important element which is required to be addressed is the taxation. The primary reason is that income of a private trust is taxed differently in different structures and any ineffective planning can lead to maximization of taxation for this entity. Check – Estate Planning through Life Insurance

Here is a brief understanding on how a private trust is taxed and how you should plan it:

private trust taxation

Assessment of a Private Trust

Trusts are independent entities and so taxed separately. Since the income of a private trust is available only to the beneficiaries, they are taxed according to the structure in which the income is received. From taxation perspective there are two structures on which income of a private trust is taxed:

Specific Trust– In a specific trust the income is specifically received by the representative assesses on behalf of a single beneficiary. Here the individual share of the beneficiary is known- for e.g. Mr. Ram will receive 25% of the total income of the trust or a minor daughter will receive the entire benefit from the trust.

Discretionary Trust– Here the beneficiaries are more than one and the individual shares of the beneficiary is not known. The income of the trust is not received by a representative but determined by the trustees.

Taxation of Trusts in India

When the individual shares of income in a private trust is identifiable, than the income is taxed in the hand of the respective beneficiary.  But since income tax imposes the liability to pay tax on the trustees, in respect of any income which he receives or is entitled to receive on behalf or for benefit of the person, the tax can be levied and recovered from a representative assesse which is the trustee.

The same is not true for a discretionary trust. Since the share of income is not defined and trustees decide the distribution of the same among the beneficiaries, the income of such trust is assessed in the hand of the trustees only at the maximum marginal rate.

The above taxability rule is applicable when the income source of the trust is only from its assets. But the situation will be different when a trust has other sources of income such as a business.

Taxation of Business Income

It may happen that a trust start its own business and derive income from it for utilization for the objectives. In such a case, the income earned form the business belongs to the trust and not to the author of the trust or trustees. Such business income of a private (specific) trust which consists of profits and gains of business income, tax is charged on the whole income at maximum marginal rate. However there are certain exemptions where the taxability remains as per individual tax rate:

  1. When a private trust is created by a will for the benefit of relatives.
  2. It is created exclusively for the benefit of any relative dependent on the support and maintenance.
  3. It is the only trust declared by the settlor.

In all the above cases, even if there is a business income, the income will be charged at the same rate and in term a manner as it would be taxed in the hands of the beneficiary.

One larger point to be noted is that there is no basic exemption available when the taxability is at maximum marginal tax rate.

Taxation at Rates applicable to AOPs

There are some instances in a private trust when the income of the trust can be taxed as if it were the total income of an association of persons-

  1. When none of the beneficiaries has any other taxable income which exceeds the basic exemption. If there are multiple beneficiaries and even one has the taxable income, the income of the trust will be charged at maximum marginal tax rate.
  2. When none of the beneficiary is a beneficiary at any other trust. If even one is beneficiary at any other trust, the income will be charged at maximum marginal tax rate.
  3. The income of the trust is receivable through declaration by any person under will and it’s the only trust declared by him.
  4. If the income of the trust (other than created by Will) is created before 1.3.1970, exclusively for the benefit of the relatives of the settlor, or of the members of a Joint HUF when trust is created by family, in circumstances when the relatives or members were mainly dependent on the settlor of their support r maintenance.
  5. Income is receivable by trust on behalf of superannuation fund, provident fund, gratuity fund, pension fund or any other fund created exclusively for the benefit of his employees.

When you are creating a private trust you are actually creating a separate tax entity and so care has to be taken not to maximize the taxability on the income of the trust. Here are few tips on how you can ensure the taxability of the private trust income stays lower and it meets the objectives in an efficient manner:

  1. Avoid any business activity from the private trust you create for the benefit of your relatives.
  2. Ensure same beneficiaries are not created in more than one trust.
  3. If the trust is for minor son or daughter or spouse, ensure the fund are not through father or husband since in that case the income will get clubbed with them.
  4. Make private trust 100% specific beneficiary for major son or daughter so that money cannot be misused by son in future or relatives of daughter when she gets married.

Hope this post gave you clear Idea of Private Trusts in India & their taxation. If you still have any question – feel free to ask in comment section.