By Suresh Surana
There are various ways an individual can pass on his assets to family members. Some of the commonly used routes to pass on assets are: Will, gift and Private Family Trusts. Apart from these, even a Hindu Undivided Family (HUF) can play an important role in passing on of assets to one's family members.
Unlike a Will and gift, both trusts and HUFs take into account the needs of the owner of the assets during his lifetime, the family structure, the nature of assets, the requirement of family members, preservation of wealth, smooth succession and so on.
Trust and HUF have some similarities and differences. Depending on the intended beneficiaries, an individual can decide between a trust and HUF or use both if will or gift deed does not suit the requirements.
Private family trusts
A Trust is a legal arrangement through which the owner of the asset transfers the property to the Trust for the benefit of one or more beneficiaries. The trustee holds the property in representative capacity on behalf of the beneficiaries and not for his personal benefit. The person who transfers the assets is called the author or settlor of the Trust. The person appointed by the settlor to administer the Trust is called the trustee. The person/s for whose benefit the Trust is formed is/are called the beneficiary/ies. The instrument by which the Trust is declared is called the "instrument of trust" (commonly known as the trust deed). Do note that a beneficiary may also be the trustee of the Trust. The share of the beneficiary/ies could be at the discretion of the trustee/s or a fixed share specified by the settlor.
A private Trust can be set up as a revocable or irrevocable Trust, with shares of the beneficiary being either discretionary or determinate. A revocable trust can be revoked (cancelled) by its settlor at any time. This is useful where the settlor wishes to retain control over the assets during his lifetime or for a certain period without having to go through the process of "probate" or "inheritance".
In this article we have considered irrevocable private Trust as a method of transferring assets. This is because such private Trusts are more tax efficient than revocable private Trusts.
Tax implications - Private irrevocable trusts as per Income Tax Act, 1961
At the time of creation of Trust
Settlor (i.e., Transferor) perspective - According to the provisions of section 47(iii) of the Income-tax Act, any transfer of a capital asset such as shares to any irrevocable trust is not considered as a transfer and consequently, no capital gains shall be attracted on such transfer/contribution of assets.
Trust (i.e., Transferee) Perspective - As per section 56(2)(x), if any sum of money or property is received from an individual by a Trust (solely created for the benefit of the relative/s of the individual), then such sum or property will not be treated as deemed income in the hands of the recipient (i.e., the Trust). Hence, no tax liability will trigger on receipt of such assets.
The term "Relative" in the above paragraph means spouse of the individual, brother or sister of the individual and any lineal ascendant or descendant (children/grandchildren/parents) of the individual or his/her spouse. It also covers brother or sister of the spouse of the individual, brother or sister of either of the parents of the individual. Further, it covers spouse of the above persons and in case of a HUF, any member thereof.
Care should be taken to ensure that any person who does not qualify as "relative" as per the Income-tax Act is not a beneficiary of the Trust (for instance, nephew or niece). As otherwise, the benefit of exemption (to the Trust) on receipt of any such sum or specified property will not be available and would lead to tax exposure in the hands of recipient i.e., the trust under section 56(2)(x) as received "for inadequate consideration" or "without " under the head of "Income from Other Sources".
Income accruing to the irrevocable Private Trust
The income of the irrevocable discretionary Trusts is generally subject to tax at the highest rate of 30%, plus surcharge and cess (effective tax rate of 39% flat ) under the new tax regime (42.744% under the old tax regime). However, in case the shares of the beneficiaries are determinate, the beneficiaries can include their respective shares from the trust income in the their personal tax returns and the same would be taxed at the individual slab rates. There are no specific benefits or deductions available to the Trusts.
Distribution of income to beneficiary from Private Trust
and flexibility with the trustees regarding management and distribution of income and assets. This is also useful where there are minor beneficiaries or dependant family members. "Ring fencing" of assets in a Trust structure can provide individuals or organisations with enhanced asset protection by separating and safeguarding specific assets from potential risks, liabilities, guarantees or claims that may arise from other areas of an individual's or organisation's affairs.
The greatest merit of the Trust structure is that it ensures smooth succession in a flexible manner without the need for probating of the Will which requires court proceedings.
On the other hand, the demerits of the Trust are taxation at the maximum marginal rate (30% plus surcharge and cess) without the benefit of lower tax slabs and administrative effort and cost to settle the Trust, maintain separate records, separate tax filings and banks requiring KYC information for all beneficiaries.
HUF
An HUF consists of persons governed by the Hindu religion and lineally descended from a common ancestor and includes their wives, sons and daughters. Basically, an individual becomes a member of an HUF by his/her birth in the family. It is one of the greatest endowments of centuries of Indian wisdom which provides for the pooling of the family assets without fragmentation for the benefit of the family members. The concept of HUF also defines the Karta as the manager of the family assets owned by the HUF.
Some of the benefits of having an HUF include:
- HUF can provide for the transition of assets from generation to generation as HUF never dies.
HUF is a tax efficient structure considering income is taxed at slab rates applicable to individuals and also the availability of basic exemption limit. The benefit of capital gains exemption in case of re-investment in residential house property under section 54 as well as 54F is available to
- HUF, subject to fulfilment of applicable conditions. The exemption for two self-occupied house properties from notional income-tax is available.
- HUF (and assets of the HUF) can be partitioned by the Karta or by the coparceners on which there is no tax implication. However, stamp duty may be applicable depending on the applicable state law. It may be noted that only a "total partition" is recognised for tax purposes.
- Deduction up to Rs 1.5 lakh for specified investments is available under section 80C of the Income-tax Act. Tax Deduction for mediclaim health insurance taken for the members of an HUF is available under section 80D.
Merits and de-merits of HUF
HUF is beneficial in case taxpayers have ancestral property as well as if the beneficiaries are minors or differently abled and also to ring-fence the assets for future generations. However, in the case of an HUF, there is less flexibility in terms of the eligible beneficiaries and their share/s. Also, this can only be relevant for those governed by Hindu law, which of course includes Jains and Sikhs.
Difference between HUF and Private Trust for succession planning
The greatest merits of the HUF over Private Trust are (a) benefits of tax slabs which can result in taxation at much lower rates (0% to 30%) as compared to the maximum marginal rate of 30% which would apply to private discretionary trusts and trusts having beneficiaries with taxable income, (b) exemption for two self-occupied house properties from notional income-tax and reinvestment tax exemption for investment in residential house under section 54/54F of the Income-tax Act and (c) reduced exposure to estate tax/inheritance tax (since HUF never dies).
On the other hand, the demerits of the HUF are that it is inflexible as HUF members have a defined share and need for a family member to be the Karta/Manager (whereas a Trust can use non-family members or professional trustees). The Trust is more flexible in terms of the selection of beneficiaries and their respective shares can be specified or can be left to the discretion of the trustees.
( The writer is Dr Suresh Surana, Founder, RSM India)
:max_bytes(150000):strip_icc():format(webp)/greenshoe-final-4d1acc3a634849f481f90f5a67862312.png)