Taxation of Discretionary Trusts [Section 164(1)] under Liability in Special Cases :
Section 164 deals with taxation of trustees of discretionary trusts. This section applies in the case of a representative assessee referred to in clause (iii) or clause (iv) of sub-section (1) of section 160 in a case where any income or part thereof is not specifically receivable on behalf of or for the benefit of any one person or where the individual shares of the persons on whose behalf or for whose benefit such income or such part thereof is receivable are indeterminate or unknown.
The representative assessees referred to in clauses (iii) and (iv) of section 160(1) are the Court of Wards, the Administrator General, the Official Trustee or any receiver or manager including any person whatever his designation who in fact manages the property on behalf of another, appointed by or under any order of a Court and a trustee appointed under a trust declared by a duly executed instrument in writing whether testamentary or otherwise (including any Wakf Validating Act, 1913).
Such a discretionary trust will be liable to tax at the maximum marginal rate of income -tax on their entire income.
With a view to obviating hardship in genuine cases where the circumstances are such that tax evasion could not be considered to be main purpose of creating a trust, certain exceptions have been specified where the trust would not be taxed at the maximum marginal rate. The exceptions are as under:
(1) Where none of the beneficiaries has any other income chargeable to tax or is a beneficiary under any other trust. In this context, the expression, “income chargeable to tax” would mean total income above the exemption limit for the relevant assessment year. Thus the income of a discretionary trust will be chargeable to tax at the maximum marginal rate in cases where any of the beneficiaries has any other taxable income exceeding the exemption limit or if any of the beneficiaries is a beneficiary under any other trust.
(2) Where the discretionary trust is created under a will and such trust is the only trust so created under the will.
(3) In case of a discretionary trust created prior to 1.3.1970 by a non-testamentary instrument if the Assessing Officer is satisfied that the trust was so created bona fide exclusively for benefit of the dependent relatives of settlor or where the settlor is a H.U.F. for the benefit of the members of such families in circumstances where such relatives or members are mainly dependent on the settlor for their support and maintenance.
(4) In cases where the income is receivable by the trustee on behalf of provident fund, superannuation fund, gratuity fund, pension fund or any other fund created bona fide by a person carrying on a business or profession exclusively for the benefit of persons employed in such business or professions.
In the above four cases the income of the trustees will be taxed not at the marginal rate but at the rate applicable to the income of an association of persons.
Where any income in respect of which a trustee appointed under a trust declared by a duly executed instrument in writing whether testamentary or otherwise, is liable as a representative assessee consists of or includes profits and gains of business, the above concessional treatment i.e. assessing the income at the rate applicable to an AOP will apply only if such profits and gains are receivable under a trust declared by any person by will exc lusively for the benefit of any relative dependent on him for support and maintenance and such trust is the only trust so declared by him.
For the purposes of these provisions a trust under which a discretionary power is given to the trustees to decide the allocation of the income every year or a right is given to the beneficiary to exercise the option to receive the income or not each year will all be regarded as discretionary trusts and assessed accordingly. This is made clear in Explanation 1 to section 164 which provides as under.
(a) Any income in respect of which the Court of Wards, the Administrator General, the Official Trustee, receiver, manager, trustee or mutawalli appointed under a Wakf deed is liable as a representative assessee or any part thereof shall be regarded as not being specifically receivable on behalf or for the benefit of any person unless the person on whose behalf or for whose benefit such income or such part thereof is receivable during the previous year is expressly stated in the order of the Court or the instruments of trust or wakf deed, as the case may be, and is identifiable as such on the date of such order, instrument or deed. For this purpose, it is not necessary that the beneficiary in the relevant previous year should be actually named in the order of the Court or the instrument of trust or wakf deed, all that is necessary is that the beneficiary should be identifiable with reference to the order of the Court or the instrument of trust or wakf deed on the date of such order instrument or deed.
(b) The individual shares of the person on whose behalf or for whose benefit such income or part thereof is receivable will be regarded as indeterminate or unknown unless the individual shares of such persons are expressly stated in the order of the court or the instrument of trust or wakf deed, as the case may be, and are ascertainable as such on the date of such order, instrument or deed.
This explanation seeks to prevent trustees and beneficiaries from manipulating the arrangements in such a manager that a discretionary trust is converted into a specific trust whenever it suits them tax-wise.
- Income from property held under wholly for charitable or religious purposes [Section 164(2)]: In case the income, in respect of which the shares of the
beneficiaries are indeterminate or unknown, is derived from property held under trust wholly for charitable or religious purpose or which is of the nature referred to in section 2(24)(iia) (voluntary contributions received by a trust) or which is of the nature referred to in subsection (4A) of section 11 (business income received by a trust), the tax shall be charged on so much of the income as is not exempt under section 11 or 12 as if the income not so exempt were the income of an association of persons.
- Where the whole or any part of the relevant income is not exempt under section 11 or section 12 because any income thereof is for the benefit of
prohibited persons or the rules with regard to investments in specified channels have not been followed, tax shall be charged on the relevant income or part of relevant income at the maximum marginal rate.
- Income from property held under trust partly for religious purposes and partly for other purposes [Section 164(3)]: If property held under trust partly
for religious purposes and partly for other purposes and the individual share of the beneficiaries in the income applicable to purposes other than charitable purposes is not known, tax liability will be the aggregate of the following:
(a) the tax which would be chargeable on that part of the relevant income which is applicable to charitable or religious purposes (as reduced by the income, if any, which is exempt under section 11 as if such part (or such part so reduced) were the total income of the association of persons; and
(b) the tax on that part of income which is applicable to purposes other than charitable or religious and in respect of which shares of beneficiaries are indeterminate or unknown, at the maximum marginal rate.
However, in the following cases, income will be charged to tax as if it were income of an association of persons:
(a) where none of the beneficiaries has any other income chargeable to tax i.e. income should not exceed the maximum amount not chargeable to income-tax and none of the beneficiaries is a beneficiary under any other private trust; or
(b) where the trust is created by will and such trust is the only trust so declared by him; and
(c) where the trust is a non-testamentary one created before March 1, 1970 for the exclusive benefit (to the extent it is not utilised for charitable or religious purposes) or relatives of the settler mainly dependent on the settler for their support or maintenance or where settler is a Hindu undivided family, for the exclusive benefit of its members so dependent upon it.
(1) Where the relevant income consists of or includes profits and gains of business, the preceding concessional method of taxation shall apply only if the
income is receivable under a trust declared by any person by will exclusively for the benefit of any relative dependent on him for support and maintenance and such trust is the only trust so declared by him.
(2) Where the whole or any part of the relevant income is not exempt under section 11 or section 12 because any income thereof enures to the benefit of prohibited persons or the rules with regard to investment in specified channels have not been followed, tax shall be charged on the relevant income or part of relevant income at the maximum marginal rate.
- Taxation of Oral Trusts [Section 164A]: Under this provision, any income which a trustee receives or is entitled to receive on behalf of or for the benefit
of any person under an oral trust will be chargeable to income tax at the maximum marginal rate.
- Case where part of trust income is chargeable: Section 165 provides that in cases where only same portion of the trust income to which the beneficiary
or beneficiaries is/are entitled is taxable and the other portion is not taxable, the taxable portion of the income received by him from the trust as a beneficiary shall be only such portion thereof as bears to the whole income of the trust. In other words, where a part only of the trust income is chargeable to tax under this Act, the beneficiaries‘ share of the income should be taken to be that derived proportionately from the chargeable and non-chargeable portions of the trust income and should be assessed accordingly in the hands of trustee/s.
It may be worthwhile to mention here that every representative assessee is regarded in law as an assessee for all the purposes of the Income-tax Act, 1961 and is subject to the same duties, responsibilities and liabilities, as if the income were received by or accruing to or in favour of him beneficially and is thus liable to assessment in his own name in respect of the income. It has also been specifically provided that a representative assessee shall not be assessed under any other provisions of the Act in respect of any income relating to which he is representative assessee except in hi s representative capacity as provided for in section 161 of the Act. A protection has been given to the representative assessee with regard to the recovery of the tax paid by him, if any, on behalf of a beneficiary as regards the income in respect of which he is a representative assessee. Provision has also been made for the representative assessee to obtain a certificate from the Assessing Officer stating the amount which the representative assessee is entitled to retain for the final settlement of the liability.