The benefits of forming private trusts go beyond tax benefits

How do you ensure the wealth you have made in your lifetime is used properly for the benefit of your loved ones in your absence? While making a Will avoids any dispute over the control of the wealth among the legal beneficiaries, creating a private trust is taking a step further to ensure that your wealth not only benefits its rightful owners, but is also taken care of properly. And if in doing so it also minimises tax liabilities of the beneficiaries, nothing like it.

A private trust can be created by an individual with the purpose of managing her assets — moveable and immovable properties —during her lifetime and afterwards.

One can create a trust by identifying the assets/ properties to be managed, specifying the purpose and beneficiaries of the trust and appointing one or more trustees to manage the property.

The purpose of creating a trust can vary from ensuring proper care and maintenance of minor children of the owner of the property after her death, or retirement of a particular debt from theincome of the property transferred, to the trust, to the most significant of all — lowering of tax liabilities.

Private trusts offer flexibility to a person to structure it (with specific clauses) as per her convenience. It can be revocable or irrevocable. In the former, the creator continues to have control over the trust, while in the latter the creator of the trust foregoes the ownership of the property. An irrevocable trust shields the property transferred to the trust from claim of creditors, or any other claims arising out of a legal battle that the creator of the trust has lost.

TAXATION OF PRIVATE TRUSTS

Taxation of trust’s income depends on the structure of the trust. In case of determinate (or specific) trusts, where the quantum of benefit from the trust to each beneficiary is clearly specified, the income is taxable in the hand of each beneficiary. For instance, a man wants the income from his trust to be equally divided among his wife, two sons and a daughter. In case of discretionary trust, where the income of beneficiaries is not specified, the entire income is taxed in the hand of the trustee.

If the trust makes business income, the entire amount is taxed in the hand of trustee at the maximum income tax rate applicable for individuals, that is, 30 per cent +3 per cent education cess, except in case of a trust created through the will of the owner of assets with the sole purpose of maintenance of the dependents of the owner of the trust’s assets, and that the dependents are not the beneficiaries of any other such trusts.

As far as taxability of the creator of trust is concerned, if a trust is revocable, the income from the trust is taxable in her hands. In case of irrevocable trust, she is not liable to pay any tax. However, if due to death of the beneficiary the trust gets annulled, the property under the trust comes back to the creator of the trust and is liable to pay tax on income from the property.

TAX BENEFITS OF TRUSTS

Although the removal of wealth tax and restriction on the application of gift tax has taken the sheen out of trusts as far as their utility for the purpose of tax saving is concerned, they can still be an effective tool for managing incidences of tax. Let’s look at some of the ways in which one can save tax through trusts:

Avoiding clubbing of income: Trusts allow a family to distribute the income earned from trust assets among beneficiaries who are family members. This structure help the family avoid clubbing of income and thus avoiding paying tax at higher a rate. Each beneficiary would pay tax at individual tax rates, which can be lower than that in case of clubbing. For instance, income from assets of a trust during a particular financial year is Rs 40 lakh, which is distributed equally among five beneficiaries, who happen to be family members. Each beneficiary gets Rs eight lakh, and considering this is their only income during the year, the maximum applicable tax rate is 20 per cent.

If not for the trust, the creator of the trust would have to pay a maximum rate of 30 per cent on the total income of Rs 40 lakh. Keeping the income below the threshold level: In case of discretionary trust, where the income of beneficiaries are not clearly mentioned and depends on the discretion of the trustee, the income from the trust can be kept below the threshold level over which income tax is applicable. Transferring property through trusts: Creating a trust for future transfer of wealth and property to minors is a common practice among high net worth individuals. This is more out of tax consideration than anything else.

In case of irrevocable trust, the transfer of property to the beneficiary (who was a minor) upon becoming a major would not taxed for any capital gains.

No additional taxes: Unlike companies, trusts are not liable to pay taxes such as dividend distribution tax or minimum alternate tax. Therefore, any income arising out of the trust and availed by the beneficiaries are not liable to pay these additional taxes.

MISUSE OF TRUSTS

Trusts are an effective tool for minimising tax liabilities, and it is within the realm of law to avail such benefits. However, not all trusts are run in the most legal ways. Trusts are often created in a much complex manner to, at times, confuse the tax department and evade tax.

However, the tax and revenue department is getting smarter, and if one is indulging in excessive misuse of trusts for tax evasion, it is likely that the law would catch her one day. Therefore, make the most of what is provided for by the law and not try to take undue advantages of the loopholes.