How The Income Of A Private Trust Is Taxed In India?

Private trusts can act an effective estate planning tool if you have a special child, a large business to be transferred to the next generation or a large estate to protect. Although the formation of a private trust resolves many issues, a lot needs to be considered in making a private trust, especially from the taxation point of view. As the income of a trust is taxed differently in different structures, careful planning is required to reap benefits without draining much money in the form of income-tax.

Propguide shares how a private trust is taxed:

 Tax-wise: Kinds of a private trust

As the income of a private trust is available only to the beneficiaries, taxation is carried out according to the structure in which the income has been received. From tax point of view, there are two structures under which the income of a private trust is taxed:

Specific trust: Here the income is received by the representative assesses on behalf of a single beneficiary. As the individual share of the beneficiary is known, taxation is done accordingly. For instance, it should be clearly stated in the trust deed that XYZ would get 50 per cent of the total income of the trust or the author's son will draw the entire benefits from the trust.

Discretionary trust: With more than one beneficiaries, the individual shares are not known. Here the income of the trust is not received by a representative but determined by the trustees.

Taxability

If the individual shares of income in a private trust is known, the income is taxed in the hands of the respective beneficiary.  As income-tax rules mandate the liability to pay tax on trustees, the tax can be levied and recovered from a representative assesse i.e. the trustee.

But the same rule does not apply to the discretionary trust where the share of income is not defined, and trustees decide the distribution of the same among the beneficiaries. The income of such a trust is assessed in the hand of the trustees as per the tax bracket under which they fall.

The above taxability rule applies when the income source of the trust is only from its assets. The situation is different when a trust has other sources of income, including a business.

Taxation of business income

There are cases where a trust starts its own business and makes profits out of it. In this case, the proceeds from the business are the trust's property. The author of the trust or the trustees can't stake a claim. The business income of a private (specific) trust is charged on the whole income. However, there are certain exemptions which are listed below:

If a private trust is created by a will for the benefit of certain relatives.

Or, it is created especially for the benefit of a particular relative who is dependent on support and maintenance.

It is the only trust declared by the settlor.

In all the above cases, even if there is a business income, the income will be charged at the same rate and in term a manner as it would be taxed in the hands of the beneficiary.

In a nutshell, one has to be mindful of this fact that when you create a trust, you are creating a separate tax entity. Here are a few tips to ensure that the taxability of the private trust income is not heavy on the pocket.

You must refrain from carrying out any business activity from the private trust.

Ensure that the same set of beneficiaries are not created in more than one trust.

If the trust is for your minor child or spouse, ensure that the funds are not through father or husband because in that case the income will get clubbed with them.

Make private trust 100 per cent specific beneficiary for major son or daughter so that money cannot be misused by son in future or relatives of the daughter when she gets married.