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Succession planning through family trust

Succession Planning and Family Trusts are two terms that go hand in hand.  A Trust, as defined by the Indian Trusts Act 1882, is the “faith/confidence reposed in someone who acts in a fiduciary capacity for someone else.” Private Trusts have been a preferred course of action by individuals who wish to protect their assets from outside forces, helping in succession planning. The parties in a trust primarily involve the settlor, trustee and the beneficiary. The trust created by the settlor can be highly customisable as per his wish. Furthermore, he is bound to appoint a trustee who administers the trust and ensures the beneficiary's benefit. The settlor of a trust can be both a trustee and beneficiary, provided he is only one of the other beneficiaries. As the trust deed serves as the base for the trust, it shall only be administered in furtherance of the matters set out in the deed.

The success of a trust lies in how well it has been structured by the settlor. The settlor is bound to create an unequivocal declaration pertaining to the creation of trust. Furthermore, he shall specify the objectives the trust strives to achieve, which are later set out in the trust deed, and the beneficiaries to which the beneficial ownership lies after the transfer of legal ownership by the settlor to the trustee. A key factor in forming a private trust is choosing the right category of trust which aligns with the settlor's objectives. The private trust shall be revocable/irrevocable and discretionary/determinate, which shall also play a key role in the aspect of taxation. In addition to setting up the trustee, a protector can indulge in the administrative aspects of the trust, and an advisory board, which provides non-binding advice to the trustees, can also be set up.

The Need for Succession Planning Through Trusts

The concept of succession planning has been familiar to family-run businesses, whereby they strive to achieve a family legacy that may last forever. The main reason for succession planning is to preserve and pass on the family wealth to future generations, protecting it from any third-party claims. However, it is imperative that succession planning be done properly and effectively, failing which shall backfire on the family. Proper succession planning has evolved into a necessity, mostly in the case of family-run businesses, whereby it addresses all the prospective contingencies that may arise with respect to the business or property. A private family trust is one of how succession planning shall be done effectively. It acts as a shield protecting the family property from unnecessary liabilities and outside forces, ensuring that it is being passed on from generation to generation and they can reap its benefits. The drafting of a trust deed which takes into account all the aspects with respect to the property will ensure the smooth transition of the property or businesses between generations. It shall be well-equipped to tackle questions regarding control, shares, and other disputes that arise or may arise within the family trust. Furthermore, the trust deed must be drafted flexibly, making future amendments possible. The uncertainty of the future may result in a change in the circumstances or environment of the family, such as a death or divorce. In such a situation, it is pertinent that the trust holds a mechanism to tackle it. In addition to the above, the tax benefits and subjectivity to fewer regulations make a Private Family Trust the preferred mechanism for a proper succession plan.

Tax Aspects of a Private Trust

One of the main points of consideration when choosing a Private Trust for succession planning is the tax aspect. Sections 161 to 164 of The Income Tax Act of 1961 govern the Taxation of Private Trusts in India. However, how tax is levied differs depending on the type of trust.

Irrevocable Non-Discretionary Trust – A Non-Discretionary trust is one in which the shares of the respective beneficiaries are already fixed by the trust deed. The concept of representative assessee, as enumerated in The Income Tax Act, is noteworthy in this aspect. Income Tax can be levied either from the trustee in the capacity of a representative assessee or directly from the beneficiaries with respect to their income. Furthermore, double taxation shall not be allowed.

Irrevocable Discretionary Trust – A Discretionary trust is one in which the allocation of shares to the beneficiaries is based on the sole will of the Trustee. The criterion for the taxability of such a trust depends on whether the beneficiaries' income is considered as the trust's income.  As the respective shares of the beneficiaries are not known, they shall be taxed at the Maximum Marginal Rate. Furthermore, tax can be levied from either the trustee or the beneficiary, not both. A trustee is considered a representative assessee for the purpose of taxation, and he shall be taxed in the same manner the beneficiary is supposed to be taxed.

Revocable Trust – A revocable trust is one in which the settlor has the power by virtue of the deed to regain control over the income or the assets involved, providing him back the control. In such a trust, the income generated from it will be directly taxed in the hands of the settlor. Whereby there exist joint settlors, they shall be taxed in proportion to the assets held by them.

Capital Gains Tax -Section 47(iii) of The Income Tax Act is noteworthy with respect to the payment of Capital Gains Tax. The settlor of a trust shall not be bound to pay any tax with respect to capital gains that are considered to arise to him on the transfer of capital to an irrevocable trust because capital gain does not arise to him on account of such transfer. Adding on, the transferee will not be bound to pay capital gains tax since the property received from an individual by a trust for the benefit of the relative of such an individual will not be treated as deemed income in the hands of the recipient as per Section 56(2)(x). In the case of a revocable trust, all the income that arises to a person due to the revocable transfer of assets is charged as tax on the transferor and included in his total income for the purpose of taxation. However, as the settlor does not control or receive any gains from the trust property in an irrevocable trust, he will not be taxed on the income of such property.

The success of a private trust is highly dependent on how well the trust deed has been drafted. It should incorporate all the factors that are vital in the implementation of trust while remaining flexible. The trustees' and beneficiaries' powers and responsibilities are to be clearly defined. Furthermore, a mode of resolution in the unlikely event of a dispute shall be specified. The trustee and the beneficiary have no authority to do acts that fall outside the trust deed's scope. On a concluding note, a Private Family Trust is one of the best ways of succession planning if done correctly. The very customisable nature of a private trust can be considered both an advantage and a disadvantage. A trust deed which forms the basis of the trust has to be drafted diligently to ensure that it does not backfire on the settlor or the others involved in a trust.

Adv Pavan Rakesh LLM

Jr Associate

Artis Law House





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