In its recent ruling[1], the Income Tax Appellate Tribunal Bench at Delhi (ITAT) has reiterated the well-established principles, including (i) validity of Trusts; (iii) use of Trusts to hold treasury shares[2]; and (iii) the taxation of its income as a representative of the beneficiary/beneficiaries under the provisions of sections 160-166 of the Income-Tax Act, 1961 (IT Act). The ITAT further upheld the principle that trustees are to be assessed as ‘representative assessee’ in the same and like manner as beneficiaries and therefore, creation of a Trust is not a tax evasion device as the Trust will have the same tax liability and exemptions accruing to the beneficiary.
Background
Escorts Benefit and Welfare Trust (EBWT) is a private Trust established vide a trust deed dated February 14, 2012. Escorts Limited (EL) is both the settlor and the sole beneficiary of EBWT. EBWT had three trustees and an initial contribution of INR 10,000. Pursuant to a scheme of amalgamation, three companies were merged into Escorts Limited. The scheme provided that the shares held by these companies inter-se will not be cancelled, but be transferred to EBWT for the benefit of EL and its successors. As a result, post the amalgamation of the three companies, EBWT acquired shares of EL (wherein EL was the settlor and the sole beneficiary).
In assessment year 2016-17, EBWT received dividend income of INR 4,47,60,037 and it claimed exemption under section 10(34) of the IT Act as dividend distribution tax was already paid by EL under section 115-O of the IT Act. The Assessing Officer (AO), inter alia, passed an order stating that under the Indian Trust Act, 1882 (Trust Act), the Trust itself was invalid as the settlor and the beneficiary cannot be the same person. It further alleged that though some individuals were appointed as trustees, they did not have any discretion and hence the beneficiary (EL) was itself acting as the trustee of the Trust. The AO denied the benefit of exemption under section 10(34) of the IT Act, claiming that the structuring of the Trust was a colourable device, created to avoid payment of tax. Therefore, the AO demanded that the dividend income in the hands of EBWT be taxed as income from other sources under section 56 of the IT Act.
EBWT filed an appeal before the Commissioner of Income Tax (Appeals) (CIT(A)). The CIT(A) upheld the AO’s order that EBWT was created in violation of law and the dividend income received by EBWT was not dividend income since EBWT was not a valid shareholder. The CIT(A) held that since EBWT was not a valid Trust and it cannot be taxed as a representative assessee, it will have to be assessed as an association of persons.
Against the CIT(A)’s order, EBWT filed an appeal before the ITAT, wherein the ITAT overturned the ruling of the CIT(A). The ITAT held that (i) EBWT was a valid Trust as there was no embargo under the Trust Act on the settlor and the sole beneficiary being the same person; (ii) EBWT could be taxed as the representative assessee of EL; (iii) the dividend income being exempt in the hands of the beneficiary i.e. EL under section 10(34) of the IT Act would also be exempt in the hands of EBWT as the representative assessee of EL; (iv) there is no legislative provision permitting exempt income to be included as income from other sources under section 56 of the IT Act; and (v) there is lack of evidence to prove that the creation of EBWT was a colourable device to avoid payment of tax.
Key Takeaways
While the ruling is in the context of treasury shares held in a trust for the sole benefit of a corporate beneficiary, the following legal principles, which are upheld, would be applicable and relevant in respect of taxation of private trusts, including those created for the purpose of estate planning.
Validity of Trust
The ITAT discussion on validity of Trust is very important. While determining the validity of a Trust, ITAT delves into two arguments of the AO: (i) the Trust is invalid as the settlor and the sole beneficiary are the same person; and (ii) the Trust is invalid as the sole beneficiary is the de-facto trustee of EBWT. The ITAT relied on the Gujarat High Court judgment in the case of Bhavna Nalinkant Nanavati v. Commissioner of Gift Tax[3], in upholding the validity of the trust. The High Court had held that a Trust would be considered valid even in cases where the settlor and the sole beneficiary were the same person. There is no bar in the Trust Act, preventing the settlor and the sole beneficiary from being the same person. Similar structures were adopted by Government Companies (Maharatnas), which were held to be valid. Further, in relation to the sole beneficiary being the de-facto trustee, the ITAT held that the AO cannot rely on the statements of the trustees that they did not know the object and purpose of creation of the Trust and hence had no discretion in the management of the trust. The trustees have responsibilities under the Trust Act, regulatory laws and the IT Act and the ITAT held that there is no obligation generally or under these specific laws that require trustees to have knowledge about everything.
Principle of Representative Assessee
Section 160 (1) of the IT Act provides that a representative assessee, inter alia, means a trustee appointed under a Trust deed who receives income on behalf of or for the benefit of any person, in respect of such income.[4] Further section 161(1) states that a representative assessee, in respect of the income received on behalf of the beneficiary, would be subject to the same responsibilities and liabilities as if the income was being assessed in the name of the beneficiary.[5] The ITAT discussed the decision of the Supreme Court in the case of Commissioner of Wealth Tax of H.E.H. Nizam’s Family (Remainder Wealth Trust)[6], where the Supreme Court held that the trustee is assessable “in the like manner and to the same extent as the beneficiary”[7]. Further, the ITAT also relied on the decision of the Supreme Court in the case of Arundhati Balakrishna v. CIT[8], where it was held that section 166 of the IT Act clarifies that the income tax officer has the option to proceed either against the trustee or against the beneficiary, but in either case, the income to be assessed must be the same sum as what the trustee receives as the income pertaining to the beneficiary is received by them under an obligation to pass on that income to the beneficiary.
Tax Evasion
The AO claimed that the Trust was invalid as it was a colourable device created for tax evasion purposes. The ITAT engaged in both a factual and legal analysis of this issue. Relying on the principle of representative assessee, the court held that since the Trust and the beneficiary will be taxed in a like manner, the creation of a Trust cannot be said to be colourable device to avoid payment of tax. The exemption under section 10(34) of the IT Act is applicable to the beneficiary since EL has paid dividend distribution tax under section 115-O. Therefore, the same exemption would be applicable to the Trust as well. The AO also contended that the shares were held in the name of the trustee (individual) and not the Trust, which indicates that the Trust was a colourable device. However, the ITAT held that the trustees were holding the shares on behalf of the Trust, in accordance with the depository rules and public disclosures of the stock exchanges, which clearly indicate that the Trust is the shareholder. Further, the ITAT clarified that the trustees were in charge of the assets of the Trust and the settlor was not acting as the de-facto trustee. In fact, the ITAT stated that in the current situation, EL first paid corporate tax and then dividend distribution tax on dividends paid to the Trust. The ITAT therefore concluded that there was no evidence produced to illustrate that the Trust was a colourable device to avoid payment of tax.
Conclusion
Trusts are a legal and legitimate form, recognised by law for the purposes of holding of assets by another person – trustee, who may or may not be the original owner of the assets or the ultimate beneficiary of the assets. This arrangement ensures that the assets are protected, both from the original owner and the beneficiaries, till such time that the beneficiaries are expected or desired to receive the income and / or the assets. Thus, a Trust is an extremely useful form for the purposes of estate and succession planning. Unlike a will, the creation of a Trust is not susceptible to processes like probate and challenges before judicial forums. As highlighted in the ITAT ruling, the property of the Trust is legally owned and managed by the trustee(s) on behalf of the beneficiaries. This protects the Trust property from financial and other risks of the settlor as well as beneficiaries. The upholding by the ITAT of the principles of representative assessee and the validity of Trusts in light of allegations of tax evasion provides much appreciated and needed clarity on the role of private Trusts in estate planning. This ruling is thus instrumental in reposing confidence in the use of Trusts and further reinforcing the well-established principles on taxation of Trusts.
[1] Escorts Benefit & Welfare Trust v. ITO ITA No.8491/Del/2019 (Delhi ITAT).
[2] Treasury shares refer to the shares of a company held by the same company. The company could be holding these shares pursuant to a buy-back or merger/amalgamation sanctioned by the tribunal. These shares are usually held in trusts by the company.
[3] (2002) 255 ITR 0529 (Guj HC).
[4] Section 160(1)(iv), IT Act.
[5] Section 161(1), IT Act.
[6] 108 ITR 555 (SC).
[7] ibid.
[8] [1989] 177 ITR 275 (SC).
