Trust, in a legal sense, is an arrangement where a person or entity (called the trustee) holds and manages property or assets for the benefit of another person or group (called the beneficiary). The entity or person who creates the trust is known as the settlor or grantor. A trust is often used for estate planning, wealth management, and ensuring assets are used or distributed according to specific wishes.

How is Trust Formed?

The formation of a trust typically involves the following steps:

1. Intention to Create a Trust: The settlor must clearly express the intention to create a trust, which means the purpose, beneficiaries, and assets involved should be explicitly defined.
2. Trust Deed: A legal document called a trust deed is prepared, which outlines the terms of the trust, including the trustee’s responsibilities, the assets involved, and the beneficiaries.
3. Transfer of Property/Assets: The settlor transfers the property or assets to the trustee, who holds and manages these assets for the benefit of the beneficiaries.
4. Acceptance by the Trustee: The trustee must accept the terms of the trust and take responsibility for managing the trust’s assets.

Purpose and Benefits of Trust

Purpose of a Trust:

1. Wealth Management: Trusts are used to manage, protect, and distribute wealth, ensuring that it benefits multiple generations.
2. Tax Efficiency: Trusts can be structured to reduce tax liability for the settlor and beneficiaries, ensuring efficient transfer of assets.
3. Estate Planning: A trust is often created as part of an estate plan, helping ensure that assets are distributed according to the settlor’s wishes.
4. Charitable Purposes: Trusts can be established to support charitable activities, with the assets used to fund certain causes.

Benefits of a Trust:

1. Control: Allows the settlor to control how and when the beneficiaries receive assets.
2. Asset Protection: Trusts can provide protection from creditors, lawsuits, and financial risks.
3. Privacy: Trusts are generally not subject to public probate proceedings, keeping details of the estate and beneficiaries private.
4. Continuity: A trust can continue to operate even after the death of the settlor, ensuring a seamless transition of assets to the next generation.

Law Governing Trusts in India

In India, the formation and regulation of trusts are governed by the Indian Trusts Act, 1882. This law provides the legal framework for the creation, management, and dissolution of private trusts. The act outlines the responsibilities and duties of trustees and the rights of beneficiaries, as well as the conditions under which a trust can be established or dissolved.

For public trusts (charitable or religious), different state-specific legislations, like the Bombay Public Trusts Act, 1950, might be applicable. In certain cases, the Income Tax Act and other regulations related to charitable organizations may also come into play.

Taxation of Trusts

The taxation of trusts in India depends on the nature of the trust, whether it is a private trust or a public (charitable/religious) trust, and the manner in which income is distributed or applied. Here’s a breakdown of how income tax applies to trusts in India:

1. Taxation of Private Trusts

• Individual Beneficiaries Trust: In private trusts where income is distributed to specific beneficiaries (individuals or groups), taxation depends on whether the beneficiaries’ shares are determined or indeterminate.
  • Determinate Trust (Specific Trust): If the share of each beneficiary is fixed or known (e.g., a trust where each beneficiary gets a defined percentage of the income), then the income is taxed in the hands of the beneficiaries as per their individual tax rates. The trustee is treated as a representative assessee for each beneficiary.
  • Indeterminate Trust (Discretionary Trust): If the beneficiaries’ shares are not fixed or are discretionary (the trustee has the discretion to decide how much each beneficiary receives), the income is taxed at the maximum marginal rate (MMR), which is currently 30% plus applicable surcharge and cess. In this case, the trust itself bears the tax liability.
• Tax Rates: The income of a private trust may include various types, such as rental income, capital gains, or business income. These are taxed according to their respective categories. For example, capital gains in a trust will be taxed at the rates applicable to capital gains, just as they would be for individuals.

2. Taxation of Public Trusts (Charitable/Religious Trusts)

• Section 11 and 12 of the Income Tax Act, 1961: Public trusts, particularly those formed for charitable or religious purposes, may claim exemptions under Sections 11 and 12, subject to certain conditions:
  • Charitable Purpose: Includes relief to the poor, education, medical relief, and advancement of any other object of general public utility.
  • Conditions for Exemption:
    • At least 85% of the income derived from property held under the trust must be applied for charitable or religious purposes within India.
    • If 85% of the income is not applied for such purposes, it should be accumulated or set aside for application in future years for specified purposes, with appropriate intimation to the tax authorities.
    • The trust must be registered under Section 12AB of the Income Tax Act to claim these benefits.
  • Surplus Income: Income that is not applied or accumulated as per the conditions may be taxed at the applicable rates.
• Business Income: If a charitable or religious trust engages in a business that is incidental to its primary objectives and the business activities are separate and documented, the income can be exempt, provided the profits are applied for the charitable purposes. However, if the business is not incidental, the income may become taxable.
• Corpus Donations: Donations specifically made towards the corpus of the trust (capital donations meant for sustaining the trust) are not taxable. However, voluntary contributions not intended for the corpus are treated as income.

3. Tax Deducted at Source (TDS)

• Trusts are required to deduct tax at source (TDS) on certain payments made, such as salary, contractor payments, and rent, as per the provisions of the Income Tax Act. The trust needs to follow these provisions like any other entity.

4. Applicable Tax Rates

• Private Trusts: Taxed either at the rates applicable to beneficiaries or at the maximum marginal rate (30%) if indeterminate.
• Public Trusts: Subject to tax only on non-exempt income or if they fail to comply with the provisions of Sections 11 and 12. If a charitable trust is not registered under Section 12AB, it is taxed at the regular income tax rates applicable to AOPs (Association of Persons), which can go up to 30%.

Summary of Tax Treatment:

The taxation of trusts in India is thus determined by the nature of the trust, its registration status, the type of income, and how it is utilized or distributed.

Conclusion

Trusts in India serve as versatile tools for managing wealth, ensuring structured distribution of assets, and achieving charitable goals. The taxation of trusts is governed by the nature of the trust—private or public—and how income is managed and distributed.

For private trusts, taxation depends on whether the trust is determinate or discretionary, with the latter facing a higher tax burden at the maximum marginal rate. Public charitable or religious trusts, on the other hand, enjoy significant tax benefits if they adhere to the conditions laid out in Sections 11 and 12 of the Income Tax Act, such as applying at least 85% of their income towards charitable purposes and maintaining proper registration under Section 12AB. Trusts that meet these criteria can effectively minimize their tax liability and maximize their impact on beneficiaries.

Understanding these rules is crucial for effective trust management and ensuring compliance with Indian tax laws, allowing both private and public trusts to serve their intended purpose efficiently.

Also read: Indian Contract Act 1872: Salient Features and Important Sections