Family trusts, a popular tool for preserving wealth and ensuring smooth succession planning among Indian families, are now facing stricter regulations. A recent court ruling has limited the flexibility of such trusts by prohibiting the inclusion of non-relatives—such as cousins, nephews, or nieces—as beneficiaries in the future.
The court has determined that if a trust deed grants trustees the authority to add non-relatives as beneficiaries at a later date, the trust will be subject to taxation on all assets, securities, and funds transferred to it.
Impact on Discretionary Trusts
A discretionary trust is typically established by a settlor, often the family head, who transfers assets into the trust. These assets are managed by trustees—usually independent professionals or trust companies—who distribute income, such as interest or capital gains, to the designated beneficiaries.
Under the current tax laws, family trusts are exempt from income tax on the assets they receive, provided all beneficiaries qualify as “relatives” as defined by the Income Tax Act. However, the new ruling changes this landscape. Even if a trust currently includes only relatives as beneficiaries, the mere possibility of adding non-relatives in the future could trigger immediate taxation.
Flexibility in Succession Planning Affected
Many families have historically included provisions for non-relatives to address unforeseen circumstances, such as a beneficiary remaining unmarried, being childless, or experiencing a divorce. The new ruling eliminates this flexibility, potentially complicating succession planning.
Case Study: Buckeye Trust
The ruling stemmed from a case involving the Buckeye Trust, a private discretionary trust based in Bangalore. The trust managed investments worth over ₹669 crore, primarily in partnership interests. Despite filing “nil income” in 2018, the trust caught the tax authorities’ attention. The tribunal determined that the transfer of partnership interest would be taxed, treating it as “shares” under the law.
The case has raised questions among tax experts. Some argue that Section 56(2)(x) of the Income Tax Act does not apply to trusts, as trustees lack the freedom to dispose of assets as they wish. Additionally, there is debate over whether “partnership interest” should be classified as shares.
Broader Implications
This ruling is expected to make it significantly more challenging for families to establish trusts with the flexibility to include non-relatives as beneficiaries. While it aims to prevent misuse, the decision could complicate succession planning for families seeking to account for unexpected life events.
As debates among legal and tax experts continue, the ruling underscores the growing scrutiny on family trusts and their role in wealth management. Families planning to establish trusts may need to reconsider their strategies in light of these changes. payments or investments, LRS is the gateway to a world of financial opportunities.
