|CORAM:||Jason P. Boaz (AM), N. V. Vasudevan (JM)|
|SECTION(S):||161(1), 164(1), 2(31), 61, 63|
|CATCH WORDS:||AOP, discretionary trust, irrevocable transfer, revocable transfer, Specific trust|
|DATE:||October 17, 2014 (Date of pronouncement)|
|DATE:||October 18, 2014 (Date of publication)|
|FILE:||Click here to download the file in pdf format|
|Entire law on taxation of private specific/ discretionary trusts under revocable & irrevocable transfers and AOPs explained|
(i) Private Trusts could be Fixed or Discretionary Trusts. A fixed trust is a trust in which the beneficiaries have a current fixed entitlement to such income as remains after proper exercise of the trustee’s powers. On the other hand, a discretionary trust is one in which the beneficiaries have no such current fixed entitlement, but only a hope (spes) that the trustees in carrying out their duty to consider how much income might be paid to such beneficiaries will in their discretion pay that income to a particular beneficiary or beneficiaries. The beneficiaries have no interest in possession under the trust. There are various reasons why a settlor prefers to establish a discretionary trust rather than a fixed trust. Some of the important one’s being – to protect the beneficiary against creditors; to continue to exercise control over young or improvident beneficiaries; to make adjustment according to circumstances. “When a trust is set up, there is no way of knowing how the beneficiaries will fare in the future; which of them will be most in need, which will be deserving, which spendthrift, which inebriate, which will marry millionaires and which missionaries”. The trustee can take all these factors into consideration in making their decisions.
(ii) When it comes to tax on income received by the Trust on behalf of the beneficiaries, there are some implications depending on whether the trust is a discretionary trust or a non-discretionary trust. As we have already seen in terms of Sec.164(1) a trust is assessed as a representative assessee in respect of income which it receives on behalf of its beneficiaries and if the beneficiaries are not certain or shares of beneficiaries are indeterminate, tax shall be charged on the relevant income or part of relevant income at the maximum marginal rate. Explanation 1 to Sec.164 deems that in certain situations beneficiaries shall be deemed to be not identifiable or their shares are unascertained or indeterminate or unknown. These provisions have already been set out in the earlier part of this order and are not being repeated. The legislative history of the above provisions needs to be examined to find out the object of introduction of the Explanation. Sec. 164(1) was in the Act when it was enacted in 1962 but its wording underwent a change, introducing a concept of taxation at marginal rate in 1970 by the Finance Act of 1970 w.e.f. 1st April, 1970. The object and scope of this amendment were elaborated in a circular of the CBDT (Circular No. 45 dt. 2nd Sept., 1970).
(iii) Under the existing provisions, the flat rate of 65% is not applicable where the beneficiaries and their shares are known in the previous year, although such beneficiaries or their shares have not been specified in the relevant instrument of trust, order of the Court or wakf deed. This provision has been misused in some cases by giving discretion to the trustees to decide the allocation of the income every year and in other ways. In such a situation, the trustees and beneficiaries are able to manipulate the arrangements in such a manner that a discretionary trust is
converted to a specific trust whenever it suits them tax-wise. In order to prevent such manipulation, it is proposed to provide that unless the beneficiaries and their shares are expressly stated in the order of the Court or the instrument of trust or wakf deed, as the case may be, and are ascertainable as such on the date of such order, instrument or deed, the trust will be regarded as a discretionary trust and assessed accordingly.”
(iv) The object of the amendments to the provision was only that the distribution of the income should not be entirely at the discretion of the trustees and that the trust deed should regulate the shares.
(v) The basic scheme of section 61 r/w section 62 and section 63 is as follows : where under a settlement any income arises to the settlor, it has to be assessed in the hands of settlor, whether the settlement is revocable or irrevocable. If under a settlement any income arises to any other person apart from the settlor such income can still be assessed in the hands of the settlor provided the settlement is revocable. Even if a settlement on the face of it is stated to be irrevocable, if the same provides for direct or indirect retransfer of income or assets of the settlement to the settlor or gives the settlor a right to resume power directly or indirectly over such income or asset, the settlement should be deemed to be revocable.
(vi) Sec.2(31) of the Act defines the term “Person”. The definition includes “Association of Persons”(AOP). There is no definition of the expression AOP occurring in the 1922 Act. By a series of decisions, the meaning of this expression was precisely defined and tests were laid down in order to find out when a conglomerate of persons could be held to be an AOP for the purposes of section 3 of the 1922 Act. While interpreting this expression occurring in section 3 of the Indian IT Act, 1922, the Supreme Court in CIT vs. Indira Balkrishna (supra) held “an AOP must be one in which two or more persons join in a common purpose or common action, and as the words occur in a section which imposes a tax on income, the association must be one the object of which is to produce income, profits or gains”. The Supreme Court, however, administered the following caution : ‘‘There is no formula of universal application as to what facts, how many of them and of what nature, are necessary to come to a conclusion that there is an AOP within the meaning of section 3; it must depend on the particular facts and circumstances of each case as to whether the conclusion can be drawn or not”. To the above judicial exposition of what constitutes AOP, there has been a statutory rider added. The Finance Act, 2002 has inserted w.e.f. 1st April, 2003 an Explanation to clarify that object of deriving income is not necessary for AOP, BOI, local authority or an artificial juridical person in order that such entity may come within the definition of “Person” in section 2(31). If income results than they are liable to be taxed as AOP if the other conditions laid down by judicial decisions are satisfied.