Use the Lexology Navigator tool to compare the answers in this article with those from other jurisdictions. 

Trusts, foundations and charities

Trusts

Are trusts legally recognised in your jurisdiction? If so, what types are available and most commonly used?

Yes, both private and public trusts (charities) are recognised in India. While planning the succession of family assets, irrevocable and discretionary trust structures are common for the following advantages that they confer during the settlor’s lifetime:

  • smooth transition of assets and flexibility to make distributions based on specific needs of beneficiaries;
  • providing for family members with special needs;
  • strong governance mechanism to administer trust property;
  • asset and creditor protection;
  • spousal protection in case of matrimonial disharmony;
  • protection against potential inheritance tax or estate duty;
  • flexibility to adopt professionalised management and administration of trust assets; and
  • limited role of court/judicial bodies.

What rules and procedures govern the establishment and maintenance of trusts?

The Indian Trusts Act 1882 governs the creation and operation of private trusts. The Trusts Act must be read in conjunction with applicable real estate, tax and securities law that prescribe the procedure for the valid creation of the trust and settlement of assets into the trust. Similarly, public trusts (charitable and religious) must adhere to the applicable rules prescribed by the state legislations pursuant to which they are set up in addition to the Charitable and Religious Trusts Act 1920, the Religious Endowments Act 1863 and the Charitable Endowments Act 1890.

Although not rules per se, some considerations to be mindful of while setting up trusts are outlined below:

  • Parties to a trust: Ideally, all three parties should not be the same person. Necessary perspectives should be harmoniously balanced while identifying the parties (settlor/contributor, trustee or beneficiary). For instance, from a securities perspective, it is advisable that the trustee and beneficiary in some cases be individuals who belong to the promoter group. From a tax perspective, in an irrevocable trust there should be no overlap between settlor and beneficiary.
  • Registrations: Mandatorily, a case where immoveable property is settled into a trust, the trust deed must be registered and adequate stamp duties paid.
  • Regulator consent: At times, prior consent of the regulator may apply if there are sectoral regulations on whether a trust may own property and, if it may, the quantum of such assets as well as the eligibility criteria of the trustee (legal owner of the trust property) and consequent reporting – for instance, transfer of non-banking financial companies holding more than 50% of passive assets and earning more than 50% of passive income or shares of a private sector banking company above prescribed limits.
  • Tax and corporate compliances: From a tax perspective, the trust must obtain a tax identification number and file annual tax returns. Further, the trustee must also undertake necessary steps to comply with the US Foreign Account Tax Compliance Act, the Common Reporting Standard and corporate law based on assets owned by the trust.  
  • Land regulations: If the trust owns agricultural or plantation land, the land laws that set out the eligibility for holding such land, as well as applicable exchange controls, must be complied with if NRIs are parties to the trust.

How are trusts taxed in your jurisdiction?

In India, trusts are not separate legal persons. From a tax perspective, the Income Tax Act prescribes a separate mechanism to tax trusts based on their nature.

Revocable v irrevocable trusts  

In a revocable trust (akin to a grantor trust), the transferor has the power to re-assume the asset that has been settled in the trust, whereas the settlor of an irrevocable trust has no such powers. In case of the former, the income of the trust is taxed in the hands of the settlor.

Discretionary v determinate trust

In a discretionary trust, the trustee has powers to make distributions of the trust property to the beneficiaries. No beneficiary has any earmarked or crystallised interest in the trust property, whereas the interest of a beneficiary in the trust property is pre-determined and specified.

In case of an irrevocable discretionary trust, the income of the trust is taxed in the hands of the trustee (who is the legal and beneficial owner of the property) or the beneficiaries as their representative assessee in the same and like manner.

In case of an irrevocable determinate trust, the income of the trust can be taxed in the hands of either the trustee or the beneficiaries to the extent of their interest in the trust, but never both. Once the income is taxed, in the hands of either the trustee or the beneficiary (as in case of a determinate trust), no further tax applies when the income is distributed.

The taxable event that may arise during the life of the trust has been detailed below:

  • Creation of trust – from the transferor’s perspective, any transfer of a capital asset to an irrevocable trust is exempt from any capital gains tax. From the transferee’s perspective, any income or property received from an individual by a trust created or established solely for the benefit of ‘relatives’ (as defined) of the individual is exempt from the purview of tax.
  • Term of trust – the Income Tax Act provides that the income of a discretionary trust is assessable to tax at the maximum marginal rate (ie, 30%, exclusive of any surcharge and cess). However, capital gains earned by such a trust from disposal of the capital assets held by it should be taxed at the beneficial rates (if any) specified in the Income Tax Act. All income arising to a business trust is taxed at the maximum marginal rate. Therefore, it is advisable that separate trust structures be created for investment and business purposes. Further, the roll-over benefits applicable to individuals and Hindu undivided families are not extended to trusts.
  • Distribution of trust property (income and/or corpus) – since income received by the trustee would have been subject to tax already in the hands of the trustee, such income shall not be taxed again once in the hands of the beneficiaries at the time of actual distribution of such income. Corpus distributions made to beneficiaries should not be taxed either.

Foundations and charities

Are foundations and charities legally recognised in your jurisdiction? If so, what forms can they take?

Foundations are not recognised in India. Charities are organised as public trusts, societies or non-profit companies.

What rules and procedures govern the establishment and maintenance of foundations and charities?

Public trusts in India are governed by central/federal legislations such as the Charitable and Religious Trusts Act, the Religious Endowments Act and the Charitable Endowments Act, in addition to state-specific legislation (eg, Maharashtra state).

How are foundations and charities taxed?

So long as the charitable institution has been set up for a ‘charitable object’ for the benefit of the general public utility, and at least 85% of the said institution’s income is applied toward charitable purpose, and the remaining 15% is being invested in furtherance of the Income Tax Act, such income of the charitable institution is not subject to tax.

Click here to view the full article.