Irrevocable trusts offer max benefit for HNIs

MUMBAI: Trusts help high net-worth individuals (HNIs) to ensure efficient succession planning and may also result in mitigating tax liability - as dividend income in hands of individuals who are resident in India in excess of Rs 10 lakh is now taxable.

However, even non-residents have set up trusts or are looking at doing so. “Persons of Indian origin who are taxpayers in another country also favour trust structures to house their India assets. By doing so, it is possible to defer the income arising to them till the time the trust distributes funds. Thus, it reduces the tax incidence in their current country of residence," says Anil Harish, partner, DM Harish & Co, a law firm.

But setting up a trust is not as simple as it looks, as various legal ramifications need to be considered.

Legal nitty-gritty
Trusts are a complex structure and getting things right is important. To begin with, an HNI needs to set up a private trust which can hold shares.There is much more that needs to be looked at, from a legal perspective. (See graphic for glossary of legal terms).

“If a trust is to be set up by an HNI, it would have to be irrevocable. If it is revocable, then the income would still be taxed in the hands of the settlor (the HNI setting up the trust), so it would not help," explains Harish.

Irrevocable trusts offer other advantages. “There is no capital gains tax on settlement of shares in an irrevocable trust (in simple terms transferring shares to the trust). Further, if shares are transferred via a demat mechanism there may be no stamp-duty liability ," adds Pranav Sayta, family business services leader at EY-India.

In other cases, the statespecific stamp duty, which is leviable on settlement of a trust, would vary depending on whether the assets are movable or immovable. In Maharashtra, it attracts a rate of 3% and 5%, respectively .

Tax on distribution of trust funds
“Under India's current tax laws, there is no tax incidence in the hands of beneficiaries (who typically comprise of the HNI and his family members) when funds are distributed by a trust," expla ins Sayta. In case of a determinate trust, the income is taxed in the hands of the trust in like manner as it would in the case of the beneficiaries. On the other hand, in case of a discretionary trust, the income is distinct and is taxed at the maximum marginal rate of 30% plus applicable surcharge and cess.

Thus, it is possible to argue that dividend income earned by a discretionary trust would be exempt in its hands. On distribution by the trust, funds would also be exempt in the hands of the beneficiaries.

“However, a view that dividend income in excess of Rs 10 lakh in the hands of a discretionary trust is exempt has not yet been tested in courts. Caution is advised as such a view could result in litigation," says Sayta.

A holistic view is to be taken when contemplating tax structures, looking at the specific needs of each HNI, sum up experts.