Trusts: Safeguarding Seamless Transactions

(This article was first published on Moneycontrol on 7 October 2016)

In today’s complex business environment, building a business and creating wealth is an uphill battle for the entrepreneur; however, once created, ensuring that such wealth is preserved and passed on to the successive generations in order to secure their interests takes paramount importance. One of the most prominent vehicles to achieve the aforesaid objective is “Trust”. The “Trust Structure”, as it is colloquially called, seeks to safeguard assets and interests of the family members, manage wealth, create ring fence around assets, and facilitate seamless succession planning.

Overview of the trust structure

Typically, such trusts are private trusts and are governed by the provisions of the Indian Trusts Act, 1882 (the “Act”). In context of trust, a “settlor” or “author” of the trust is a person who settles or transfers the trust property to the “trustee”. The “trustee” is the person on whom the title of the trust property is legally vested upon and who is entrusted with the responsibility of managing the trust property for the benefit of the “beneficiaries”. The “beneficiaries” are in turn the person(s) for the benefit of whom the trust property is managed. The “settlor” himself may act as the “trustee” of the trust.

Depending on the identification of the share of the beneficiaries, a trust can be classified as a specific trust or a discretionary trust. A specific trust is a trust wherein the individual shares of the beneficiaries are identified whereas in case of a discretionary trust, the share of the beneficiaries is as per the discretion of the trustee.

Although the basic legal principles governing a trust are laid down under the Act, the trust retains the flexibility of being administered by a “trust deed”. The trust deed is the master charter which lays down the desires of the settlor, inter alia, specifying the objectives of the trust, the roles of responsibilities of the trustees, the manner of distribution of income/ assets from the trust to the beneficiaries, various governance provisions of the trust such as manner of decision making by the trustees, succession of the trustees in case of the original trustees ceasing to be the trustees, etc.

Therefore, the trust deed is essentially a “living will” of the settlor since it captures the wishes of the settlor with respect to the management of the trust property not only during his lifetime but also after his lifetime so as to ensure seamless transition from one generation to another.

Benefits of trust structure

Generally, in the Indian context, the entrepreneurs themselves or through a holding company hold the shares of the operating companies. Therefore, more often than not, the subject-matter of the trust becomes the shares in the operating companies. Since all the family members would not be inclined to manage the affairs of the business on a day-to-day basis, the trust structure enables segregation of ownership from the control/ management of the operating companies. The trust deed may provide for identification of managerial roles for certain family members while on the other hand can also provide for share of ownership of trust property (equity stake in the operating companies) for various family members without necessarily having to devolve managerial roles to them.

Further, a trust structure also ensures smooth transition of the trust property from one generation to another. Historically, the ownership of the assets were passed onto future generations by executing a “will”. However, a will did not address whether various pertinent issues such as the management of operating companies, conflict resolution in case of a dispute as to the ownership of a particular property, etc. Since the trust serves as a living will which operates during the lifetime of the entrepreneur, it facilitates smooth transition of wealth.

Moreover, transfer of assets from one generation to another, prior to 1985, was subject to estate duty leviable upon the death of the transferor. Although the estate duty has been repealed, the renewed buzz around reintroduction of estate duty certainly makes a persuasive argument in favour of migration of family assets to a trust structure during the lifetime of an entrepreneur. A combination of specific trusts and discretionary trusts could achieve the twin objectives of succession planning as well as estate duty planning.

Taxation of trusts

Since the trust is merely a legal obligation cast upon the trustee and not a legal person, the taxing provisions of a trust are complex. In the case of a specific trust, the beneficiaries are directly assessed in the proportion of their beneficial interest. Since the trust is treated as a pass through entity, the nature of income taxable in their hands would depend on the nature of income accruing to the trust. If the trust income includes profits from business, the whole income is taxable at maximum marginal rate and in other cases, at the applicable slab rate or if the income is exempt (such as dividend, long term capital gains on sale of listed shares, etc.), no tax would be chargeable on such income.

In case of discretionary trust, the trust itself is taxed at maximum marginal rate on the income accruing to it. However, if any income is exempt, such income continues to be not taxable in the hands of the trust.

Any trust, per se, is treated as a pass through entity. Any distribution of income or assets from the trusts to its beneficiaries is not be taxable in the hands of the beneficiaries at the time of distribution.

Trusts: Paving a way forward!

Given the overwhelming benefits of holding the family assets through to a trust structure, many major business houses in India have already migrated or are contemplating to migrate to a trust structure. Designing a legal yet flexible framework by way of a trust deed for protection of family assets, securing the interests of all the family members including ensuring upkeep of members with special needs/disabilities, segregating ownership from management of operating companies and defining particular code for conflict management are only few of the numerous advantages to pave a way forward for trust structure to ultimately achieve the objective of seamless transition of wealth to Gen Next!!!