Case Study-Taxation of Trust and Beneficiaries of cross border Discretionary Trust

1. Case Study-Taxation of Trust and Beneficiaries of cross border Discretionary Trust Daksha Baxi 28 June Mumbai - IFA India Br - WRC Khaitan & Co. Advocates, Solicitors, Notaries, Patent & Trademark Attorneys Copyright © Khaitan & Co.

2. Case Study Outline A Non- resident person sets-up a Discretionary Trust in BVI. The beneficiaries of such a trust are: Indian Resident Individuals and British Residents. The Trust makes investments in offshore companies/assets and earns income. The Trust is not subject to tax in BVI. ...Cont’d 2 Privileged & Confidential

3. Outline (Cont’d) Trust derives income in the form of interest, dividends and capital gains from its investments in the offshore companies. Three alternative scenarios as regards the person who is the trustee of the trust: (i) A person resident in BVI; (ii) A person resident in the UK; (iii) A person resident in India. 3 Privileged & Confidential

4. Structure Investments Offshore Company Discretionary Trust Earns income Trustee: i) BVI Trustee (ii) British Trustee (iii) Indian Trustee Settler (Non UK Resident) Beneficiaries (British Residents) Offshore Jurisdiction India Beneficiaries (Indian Residents) 4 Privileged & Confidential

5. Issues Whether the Trust will be liable to tax in India in scenarios (i), (ii) and (iii) on its income? Whether the Indian resident beneficiaries will be subject to tax in India on the income earned by the Trust when the trust receives the income but the same is not distributed in all the three scenarios? Whether the Indian resident individual would be liable to Indian tax when income is distributed by the Trust in all the three scenarios? 5 Privileged & Confidential

6. Issues (Cont’d) Whether the British resident individuals would be liable to Indian tax when the income is not distributed by the Trust in all the three scenarios? Whether British resident individuals would be liable to Indian tax when the income is distributed by Trust in all the three scenarios? Whether the Indian resident beneficiaries be taxed in the UK on the income from the trust? Whether the Indian resident beneficiaries would be able to claim credit in India for any foreign tax paid on the income of the foreign discretionary trust, distributed to him? 6 Privileged & Confidential

7. Relevant portion of Section 5 of the ITA, 1961 (1) Subject to the provisions of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which- (a) is received or is deemed to be received in India in such year by or on behalf of such person; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year; or (c) accrues or arises to him outside India during such year (2) Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which- (a) is received or is deemed to be received in India in such year by or on behalf of such person; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year. 7 Privileged & Confidential

8. Section (160) (1) (iv) of ITA 1961 Representative assessee. (1)For the purposes of this Act, "representative assessee" means- ……. (iv) in respect of income which a trustee appointed under a trust declared by a duly executed instrument in writing whether testamentary or otherwise, receives or is entitled to receive on behalf or for the benefit of any person, such trustee or trustees 8 Privileged & Confidential

9. Section 161 (1) of the ITA, 1961 Liability of representative assessee (1)Every representative assessee, as regards the income in respect of which he is a representative assessee, shall be subject to the same duties,……. as if the income were income received by or accruing to or in favour of him beneficially, and shall be liable to assessment in his own name in respect of that income; but any such assessment shall be deemed to be made upon him in his representative capacity only, and the tax shall, ……. be levied upon and recovered from him in like manner and to the same extent as it would be leviable upon and recoverable from the person represented by him. 9 Privileged & Confidential

10. Section (164) (1) of ITA, 1961 Charge of tax where share of beneficiaries unknown. Any income in respect of which the persons ……. are liable as representative assessees or any part thereof is not specifically receivable on behalf 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…tax shall be charged on the relevant income or part of relevant income at the maximum marginal rate [Emphasis provided] 10 Privileged & Confidential

11. Points to be considered For the beneficiaries, or the trustees as representative of beneficiaries to be taxed in India, the following needs to be determined: Whether the income of the Foreign Discretionary Trust falls within the scope of total income u/s 5 of ITA in the hands of the beneficiaries- whether Indian or British If the income is not within the scope of section 5, can the trustee who is not resident in India, be taxed as representative assessee? 11 Privileged & Confidential

12. SC in Kamalini Khatau Case [1994]209ITR101(SC) Revenue has option to assess either the trustee or the beneficiary in respect of income received by the beneficiary in case of a discretionary trust........ Section 166 is not attracted unless discretion as to the distribution is exercised. Applying the above: Beneficiary can only be taxed when the income from the foreign discretionary trust vests in him upon the trustee exercising the discretion in his favour. Income cannot fall within section 5 for the beneficiary till the discretion has been exercised. . 12 Privileged & Confidential

13. Where Trustee is Indian Resident (S.164(1)) Trustee as representative assessee is assessable as if income were received by him beneficially. However, the tax can only be levied on him in the manner and to the extent leviable upon person(s) represented by him. Where some beneficiaries are UK resident and the others are Indian resident, and no discretion has been exercised by the trustee, how would the tax be levied on trustee in the like manner and to the extent leviable on the beneficiaries? Failure of mechanism to compute tax ? – SC in Srinivasa Shetty’s case- [1981] 128 ITR 294 (SC) On the other hand, difficulty in computing tax cannot mean that the tax is not to be levied. UNCERTAIN POSITION 13 Privileged & Confidential

14. Answers to Issues • Whether the Trust will be liable to tax in India : • Where the Trustee is resident in BVI - No • Where the Trustee is resident in UK – No • Where the Trustee is resident in India – Uncertain • Whether the Indian resident beneficiaries will be subject to tax in India on the income of the Trust when the same is not distributed under : • No • No • Uncertain • Whether the Indian resident individuals would be liable to Indian tax when income is distributed by the Trust in all the three scenarios? Yes 14 Privileged & Confidential

15. Answers to Issues 4. Whether the British resident beneficiaries would be liable to Indian tax when the income is not distributed by the Trust in all the three scenarios (i) and (ii) - NO (iii) NO But under the ITA, taxed in India if the income received in Indian bank account S. 5(2)(a) Under the DTAA, not taxable in India since it does not “arise” in India as per the DTAA and the asset is not located in India Whether British resident individuals would be liable to Indian tax when the income is distributed by Trust in all the three scenarios? - NO 15 Privileged & Confidential

16. Answers to Issues 6. Will the Indian resident beneficiaries be taxed in the UK on the income from the trust ? If the BVI Trust is regarded as offshore trust in the UK, it would not be taxed in the UK, (as per the new provisions of the UK Budget 2008). If by virtue of the trustee being a UK resident, the trust is not regarded as offshore trust, then, it may be taxed in the UK @ 40% When income is received by a beneficiary from a discretionary trust, it is deemed that the income has been subjected to 40% tax in the UK. Indian residents, who are not ordinarily resident of UK, are not subject to tax in the UK on trust income. They can claim refund of the tax deemed to have been paid by the trust in UK. Thus, the Indian resident beneficiaries should not be taxed in the UK under the UK domestic law 16 Privileged & Confidential

17. Open Issue Whether the Indian resident beneficiaries would be able to claim credit in India for any foreign tax paid on the income of the foreign discretionary trust, distributed to them. Debatable and dependent on the country in which the income arises. Whether the Indian tax department would recognise the tax paid by the trustee as being the tax suffered by the beneficiaries ? Relief u/s. 91 of the ITA ? . 17 Privileged & Confidential

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