An effective family business succession planning not only establishes a smooth transition of leadership in the business between generations, but it also ensures that the control over the business is retained in the family. In addition, adequate wealth planning could also help prevent unwarranted long and expensive legal disputes between heirs in multiple jurisdictions.
Family business succession planning can be achieved through various structures depending upon parameters like the degree of control over the purpose for which the wealth can be used, the manner in which it may be used and the like. One of the most common structures to manage family wealth is “Private Family Trust”.
The fact that a private trust offers numerous advantages, (safeguarding against possible losses due to family-related liabilities which may arise from unforeseen events divorce, death, re-introduction of estate duty in India, etc. to mention a few ) and the ease and flexibility of formulating the mechanics to ensure that the needs, requirements and the objective of the entire family are met, makes it a popular arrangement while planning the transition of family business.
Structuring a Private Family Trust – Key Considerations
A trust may be created through a non-testamentary or by way of a testamentary document (like will). Pursuant to the Indian Trust Act, 1882, (“Trust Act”) there are four important components of a valid trust one should consider while structuring a family trust for business succession:
- The person who creates a trust (settlor/author) should make an unequivocal declaration of an intention on his part which must be manifested through an external expression of it (by written or spoken words or by conduct) as opposed to an undisclosed intention.
- The settlor must clearly define and specify the objects. Since the purpose has to be accomplished by a trustee (person/entity on whom trust is reposed), who may not always be the author/ settlor himself, it is necessary that the purpose is clearly declared so that the trustee can faithfully accomplish the author’s purpose, for which the author has reposed confidence in the trustee.
- The settlor must specify the beneficiaries. Where there is no transfer of ownership, there is no trust. The settlor gives up the ownership of the property thus resulting in transfer of legal ownership of the property to the trustee and transfer of beneficial ownership to the beneficiaries of the trust.
- The settlor must transfer an identifiable property under an irrevocable arrangement and totally divest himself of the ownership and the beneficial enjoyment of the income from the property.
Once the nature and type of private family trust (i.e. discretionary/determinate, revocable/irrevocable) is finalized, amongst others, following key considerations with respect to the structuring of the trust should be kept in mind:
- Registration and Stamp Duties
A trust deed may be created in a detailed manner, stating the above, preferably with the help of a legal practitioner. The deed should be registered if the transfer of immovable property is involved. However, no formal deed is necessary for recognition of trust created by a will.
Stamp duty would be levied on any such settlement of immovable property to a trust. Although in a few states the stamp duty on gifts to specified relatives is minimal, the same does not apply to trusts and for this reason, transfer through a will is preferred. To minimize the amount of stamp duty, properties are often held through entities, the ownership of which is then transferred to the trust.
A trustee has a fiduciary obligation under law to hold the trust property for the sake of the beneficiaries and is empowered to manage the affairs of the trust. Accordingly, it becomes important to choose the most suitable type of trustee (i.e. a trustee may be an individual, either a trusted family advisor or a member of the family itself). The Settlor or one of the beneficiaries may act as the trustee so long as they operate in that capacity.
Alternatively, the services of an institutional trustee may be employed, especially in instances where neutral decision-making is a primary concern. The family may also consider setting up a Private Trust Company (“PTC”) with family members appointed as directors of the PTC to make decisions with respect to the trust.
While the choice of trustee depends upon the commercial requirements of the family business, a few important parameters listed below need to be considered while making the decision:
- the level of control the family would like to maintain in day to day operations;
- neutrality of the trustee;
- objective and term of trust;
- expertise with respect to the discharge of various fiduciary duties;
- annual costs.
The powers of the trustees are defined in the trust deed and the same vary depending upon the structure of the trust and the requirements of the family business. Generally, a trustee has wide-ranging powers that allow him to manage the daily operations of the trust and make distributions to beneficiaries. In order to balance the powers of the trustee, the trust deed may provide for the appointment of a Protector. The role of the Trust Protector is advisory in nature, however, making a provision in the Trust Deed that the trustee must consult the Protector before making key decisions would help to ensure that the decisions by the Trustee are made in the best interest of the family.
The Supreme Court (“SC”) of India in the case of Vimal Shah & Ors. vs Jayesh Shah & Ors. has held that:
“…all disputes arising out of a trust deed and the Trusts Act are not arbitrable in India.”
This has put an end to arbitration as a form of dispute resolution for trusts. The SC analysed the scheme of the trust act finding that it comprehensively and adequately covers each subject pertaining to trust law, right from the creation of the trust and extending to the management of the trust as well as provisions relating to beneficiaries and trustees, including remedies available to get grievances settled. Specifically, on the point of legal remedies, the SC observed that the trust act provides specifically for the resolution of various disputes and confers jurisdiction for the same on Civil Courts. The SC referred to the principle of interpretation that where a specific remedy is prescribed by statute, the person facing such a grievance is denied of any other remedy. Therefore, the SC concluded that the presence of provisions in the trust act specifically dealing with the forum for dispute resolution reflects the intention of the legislature to impliedly bar arbitration of such disputes. That being said, provisions for alternative dispute resolutions mechanisms like conciliation as governed by the Arbitration Act or mediation may still be provided for under the trust deed subject to legal advice.
It was further held in the said case that:
“as beneficiaries are not signatories to a trust deed containing an arbitration clause, any disputes arising between beneficiaries or trustees of a trust cannot be referred to arbitration as such arbitration clause is not an “arbitration agreement” between the trustees inter se, between the beneficiaries inter se or between the trustees and the beneficiaries for the purposes of the Arbitration & Conciliation Act, 1996 (“Arbitration Act”).”
Furthermore, the SC clarified that even if the beneficiaries are considered to have accepted the trust deed vis-à-vis the settlor by accepting the benefits thereunder, such acceptance does not imply that an arbitration agreement exists for the resolution of disputes among beneficiaries, among trustees, or among trustees and beneficiaries.
- Cross border Trust structure
With the number of high net worth families having members residing in various countries, the probability that a trust structure will have cross-border elements is increasing. Given that the Reserve Bank of India (RBI) has strict rules with respect to foreign exchange and the cross-border transfer of funds / immovable property, it becomes pertinent to consider the residency status of the settlor, trustee and beneficiaries of a trust.
For example, an Indian resident settlor may set up a trust outside of India (“Offshore Trust”). In fact, the Foreign Exchange Management Act, 1999 (“FEMA”) of India has granted general permission to a person resident in India to hold, own, transfer or invest in foreign currency, foreign security or any immovable property situated outside India if such ‘Foreign Currency Assets’ have been acquired, held or owned by such person when he was resident outside India or inherited from a person who was resident outside India. Such a person may set up a trust in such jurisdiction or any other jurisdiction to which he could contribute the Foreign Currency Assets. Families generally prefer to have an offshore trust set up in a tax-haven or asset safe jurisdiction as apart from deriving the jurisdictional benefit, it ensures confidentiality and buffers assets from business uncertainties.
However, remitting Indian funds to such Offshore Trust should be subject to India’s Liberalised Remittance Scheme (“LRS”), under which resident individuals are allowed to transfer up to USD 250,000 per person per financial year for permitted current and capital account transactions without prior RBI approval. These transactions include the acquisition of immovable property shares or any other assets outside of India. Funds transferred through LRS may even be used to set up a foreign company.
Further, while the Trusts Act does not preclude a non-resident from acting as a trustee to an Indian Trust, it does require that where a trustee is absent from India for a continuous period of six months or leaves India with the intention of residing abroad, then a new trustee may be appointed in his place.
Considering that Indian foreign exchange laws do not permit non-residents to directly hold immovable property, the trustee of a trust having immovable property would not be legally capable of holding such property on behalf of the trust and would therefore not be competent to act as trustee. Moreover, in the event that a trustee is non-resident, the trust should not be engaged in activities prohibited for non-residents under India’s foreign exchange regulations.
Taxation of Private Trust
Taxation of private trust in India is governed by the provisions of Income Tax Act, 1961 (“ITA”) which stipulates the provisions with respect to the determination of residence, chargeability to tax, computation of income, etc.
For the purposes of Indian Income Tax, a Private Trust is not treated as a separate taxable unit. However, under the ITA, the trustee acquires the status of that of a beneficiary and is taxed as a representative of the beneficiaries (“Representative Assesee”). The provisions dealing with the taxation of a Private Trust is stipulated under section 161 to 164 of the ITA and the same is discussed below:
- Irrevocable Determinate Trust
Given that in such Trust, the beneficiaries are identifiable and the beneficial interest of such beneficiaries have already been determined, the income of the trust can be taxed at the hands of the trustees as Representative Assesees or the beneficiaries depending on the extent of their interest in the trust, however, in no event there would be double taxation for the same income.
Further, under the provisions of ITA, any transfer of a capital asset under a gift or will or an irrevocable trust is exempt from any capital gains taxation as no gains are made by the author of the trust who transfers the property. Similarly, the property received by a trust created or established solely for the benefit of ‘relatives’ (as defined) of the individual is exempt from the purview of tax. Moreover, trusts receiving dividend income will be exempt from the additional 10% tax on dividend income exceeding Rs 10 lakh.
Another issue for consideration with regard to the taxation of a trust is the application of Section 56 of the ITA on a settlement. Section 56(2) of the ITA provides for the taxation of any sum of money and specified properties (value of which exceeds fifty thousand rupees) received without consideration or for inadequate consideration as ‘income from other sources.’ However, the said section does not apply to any sum of money/property received, inter alia, from relatives as defined in the ITA.
Therefore, where money or any property is received without consideration or for inadequate consideration, other than being from a relative, the income would be taxable in the hands of the trustee/beneficiary at the progressive slab rates, the maximum rate being 30% plus applicable surcharge and education cess.
- Irrevocable Discretionary Trust
As stated earlier, a Discretionary Trust is one which gives the Trustee, the powers to decide which beneficiary receives the fund and to what extent.
In case of a Discretionary Trust, the taxability of the trust in India would depend on whether the income of the trust is the income of the beneficiaries. No income would accrue or arise in the hands of its beneficiaries till such time that the trustee makes a decision regarding the allocation of the trust property or income to one or more of the beneficiaries and the beneficiaries become eligible to receive the property or income. In such a situation, one also needs to consider whether the trustee or the trust could be taxed under the residual category as ‘artificial juridical person’. An artificial juridical person would be subject to tax in India if it is resident in India or it receives income in India, or any income accrues or arises to it in India. Residential status of an artificial juridical person is determined on the basis of the situs of its control and management. If control and management is situated wholly outside India in the relevant year, the artificial juridical person would be treated as a non-resident for the purpose of Indian taxation.
Thus, as long as the trust’s administration and decision making are not exercised by anyone in India even for a part of the year, an offshore trust should not be regarded as resident in India and such a trust should not be taxed in India.
In case of an onshore (in India) discretionary trust having resident and non-resident beneficiaries, a trustee will be regarded as the representative assessee of the beneficiaries and shall subject to tax at the maximum marginal rate.
Under the ITA, a transfer shall be deemed to be revocable if it contains any provision for the re-transfer directly or indirectly of the whole or any part of the income or assets to the transferor or it in any way gives the transferor a right to re-assume power directly or indirectly over the whole or any part of the income or assets. Thus, where a settlement is made in a manner that a settlor is empowered to reassume possession over the assets of the trust or entitled to recover the contributions over a specified period, and is entitled to the income from the contributions, the trust is disregarded for the purposes of tax, and the income thereof is taxed as though it had directly arisen to the settlor. If there are joint settlors to a revocable trust, the income of the trust will be taxed in the hands of each settlor to the extent of assets settled by them in the trust.
Succession planning, although has been around for a long time, the changing legal and business environment has made it multifaceted and therefore complex. With rumors of a reintroduction of estate duty/ inheritance tax doing the rounds and the Bankruptcy Law being active since 2016, it is better succession planning is done well in advance to meet future ambiguities. High net-worth individuals and families need to adequately plan the future of their wealth to avoid family conflicts and weaklings being deprived of affluence they inherited. Therefore, the creation of a private trust would provide desired flexibility and ensure ease of operation as well as the possibility of correction within the lifetime of the settlor.