Introduction
Facts
Decision
Comment
Family trusts in India have become a widely popular tool not only for succession and estate planning but also for managing assets and investments. If deployed wisely, these trusts can prove to be an effective and tax-efficient structuring instrument. However, despite the advantages offered by these family trusts, contributing or settling existing assets into such trusts may pose some challenges, especially on account of certain tax provisions.
One such challenge is posed by the provisions of section 56(2)(x) of the Indian Income-tax Act 1961 (IT Act), which seeks to tax a notional income when certain assets (such as land, securities and works of art) are transferred or settled (contributed) into a trust for no consideration or for a consideration that is less than the fair market value of such assets.(1) Recently, a similar issue came before the Mumbai Income Tax Appellate Tribunal (ITAT) in the case of Balaji Trust, in which the tax authorities sought to tax the gift of the Essar brand to a family trust.(2)
In Balaji Trust, the taxpayer was a private discretionary trust, set up for the sole and exclusive benefit of the Ruia family members (promoters of the Essar group) of the settlor. In the year in which the trust was created, Essar Investment Limited (EIL) gifted the Essar brand to the trust, including all its registered and unregistered trademarks, copyrights, service marks, logos and slogans. The trust subsequently entered into a brand licensing agreement with the Essar group entities on a non-exclusive basis and offered the licence fees received pursuant to such agreements to tax. The tax officers considered the receipt of copyright, trademarks and other rights as income of the trusts and sought to tax them under the residuary head of income ("income from other sources") under the IT Act. The tax officer determined the value of the brand using the discounted cash flow method and added it to the trust's taxable income.
The trust successfully appealed against the tax officer's order. The commissioner of income tax appeals (CIT(A)) held that the trademarks and copyrights received by the trust constituted a capital receipt and could not be brought to tax in the absence of any express provision to that extent. Further, the CIT(A) also rejected the tax officer's argument that the receipt of the brand should be taxed as a receipt of a "work of art" without any consideration under section 56(2)(vii) of the IT Act (the former provision, similar to section 56(2)(x) of the IT Act). Similarly, the CIT(A) rejected the argument that the receipt of such a brand could be taxed as benefits or perquisites received pursuant to a business or profession under section 28(iv) of the IT Act.
Receipt of Essar brand not taxable as "other incomes"
The ITAT observed that in order for the receipt of a brand to be subject to tax under the IT Act, it would be relevant to show that there is either an element of revenue or profit, or that such receipt is squarely covered under the definition of the term "income" under the IT Act or any other specific provision. The ITAT observed that the brand which was transferred to the trust did not carry any value in the books of EIL. Further, the ITAT observed that the brand constituted a profit-earning apparatus with which the trust was able to generate a licence fee from the Essar group. Thus, the ITAT concluded that the brand constituted a capital asset. Therefore, where such a brand is transferred without any consideration, there is no income or profit element. Further, the ITAT also held that a gift of such a brand does not fall within the ambit of the term "income" under the IT Act, nor is it taxable under any other specific provisions of the IT Act.
Receipt of Essar brand not taxable as notional income under section 56(2)
With respect to the applicability of section 56(2)(vii), which provides for the taxation of notional income on receipt of certain property (which includes a "work of art") without any consideration or for insufficient consideration, it would have to be shown that the brand received by the trust constituted a "work of art". The ITAT clarified that the mere fact that the brand was registered as an "artistic work" under the Copyright Act 1957 would not in itself mean that the brand was also a "work of art". The ITAT observed that the term "work of art" was not defined in the IT Act and relied upon various judgments and dictionary meanings to conclude that a work of art must be a creation of human skill and should possess aesthetic beauty with artistic inputs.
The ITAT also considered the definition of the term "artistic work" under the Copyright Act, and observed that the term also includes artistic works irrespective of whether they possess artistic quality. Thus, the ITAT held that the two terms are used in different contexts and have a different scope. Based on this analysis, the ITAT held that the Essar brand was neither an artistic innovation, nor did it possess any artistic quality such that it could be recognised as a work of art. Thus, it held that the Essar brand could not be recognised as property under section 56(2)(vii) of the IT Act, and, accordingly, the receipt of such a brand by the trust could not be taxed under that section.
Receipt of Essar brand not taxable as perquisite arising from business
The ITAT also rejected the taxpayer's argument that the gift of a brand could be taxed as a benefit or perquisite arising from business or exercise of profession under section 28(iv) of the IT Act. The ITAT noted that the brand had been gifted to the trust on the same day it was created. Therefore, it could not be said that such income or benefit had arisen out of the trust's business. Further, the ITAT held that, as discussed above, the receipt of a brand constituted a capital receipt and could not be brought to tax as business income. Thus, the ITAT rejected the tax officer's argument and upheld the order of the CIT(A).
This decision provides much needed relief and clarity to taxpayers regarding the settlement of assets into a trust. However, it will be of utmost importance to analyse the facts of each case, since factors such as the nature of the transaction, the treatment of assets in the books and the nature of assets are likely to have an impact on taxation. Thus, it is of utmost importance that every contribution that is proposed to be made to a trust or any proposal to settle any asset into a trust should be vetted from a tax perspective.
Another important takeaway from this judgment is the applicability of the provisions of section 56(2) of the IT Act to copyrights and trademarks. It would also be relevant to note that, while the judgment was rendered in the context of the former provisions of section 56(2)(vii) of the IT Act, the discussion in the judgment should be equally applicable to the existing provisions of section 56(2)(x) of the IT Act. Further, unlike section 56(2)(vii), section 56 (2)(x) of the IT Act specifically exempts transfers or contributions to a trust, settled by an individual for the sole benefit of their relatives. It therefore provides more opportunities to structure the settlement of assets into a trust in a tax-efficient manner.
While this is a welcome judgment for taxpayers, it is necessary to wait and see whether the decision will be challenged.
For further information on this topic please contact Kunal Savani or Bipluv Jhingan at Cyril Amarchand Mangaldas by telephone (+91 22 2496 4455) or email ([email protected] or [email protected]). The Cyril Amarchand Mangaldas website can be accessed at www.cyrilshroff.com.
Endnotes
(1) Exempted are transfers or contributions to a trust settled by an individual for the sole benefit of their relatives.
(2) ACIT v Balaji Trust ITA No. 5139/Mum/2017 (Mumbai ITAT).