ITAT Explains Entire Law On Taxation Of Private Trusts And AOPs

DCIT vs. India Advantage Fund-VII (ITAT Bangalore)

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).