- While a zealous effort to crack down on the tax evasion, the judgment possibly runs contrary to the Supreme Court ratio in Commissioner of Wealth Tax v. Estate of Late HMM Vikramsinhji of Gondal.
- ITAT (Mumbai) allows the undistributed assets of an offshore discretionary trust to be taxed as income in the hands of the beneficiaries, based on information received from a tax evasion petition.
- Tribunal’s reasoning relies more on the fact that the trust was not originally disclosed, assuming tax evasion, than on an analysis of whether the beneficiaries can actually be taxed for the assets held by such a trust.
The recent Mumbai Income Tax Appellate Tribunal ruling in Shri Mohan Manoj Dhupelia & Ors.1 follows close on the heels of the Indian Supreme Court’s ruling in Estate of Late HMM Vikramsinhji of Gondal 2. The issue involved in both cases was similar – should the income of an offshore discretionary trust be subject to tax in India, if no distributions have been made to beneficiaries in India. While the Supreme Court had held, only a few months ago, that no tax should be payable, the Tribunal ruling has unfortunately ruled to the contrary, without adequate differentiation on facts.
In this alert, we examine whether and how this should impact the treatment of offshore discretionary trusts in India.
SUMMARY OF RULING AND ANALYSIS
The Tribunal was required to consider three appeals filed by individual relatives (“Taxpayers”) in relation to a Lichtenstein based trust, the Ambrunova Trust and Merlyn Management SA (the “Trust”). The Trust was found to have a corpus of USD 24,06,605.90, which was not declared by the Taxpayers in their returns. The revenue authorities considered this amount as the “undisclosed income” of the Taxpayers and taxed it accordingly.
The Taxpayers appealed the assessment and the following broad issues were examined:
Taxation of corpus in hands of beneficiary Taxpayers: The Taxpayers argued that the Trust was discretionary in nature, that they were not named in the list of beneficiaries, nor did they receive any distributions from the Trust. Therefore, it was argued that the corpus of the Trust could not be taxable in the hands of the Taxpayers. The Taxpayers simultaneously denied having knowledge of the Trust and claimed no connection with the Trust during assessment proceedings.
The revenue submitted factual proof that the Taxpayers were beneficiaries of the Trust, based on trustee records and other records, which were obtained through a Tax Evasion Petition (TEP) filed with Lichtenstein. While the Taxpayers do not appear to have been specifically named in the trust deed itself, the revenue authorities relied upon the beneficiary allocation contained in trustee filings, to add the corpus amounts as the “undisclosed income” of the Taxpayers.
The Tribunal held that the additions made by the revenue were justified.
Analysis: Strangely enough, the Tribunal’s ruling has turned on the fact of non-disclosure, rather than the substantive question of whether the income of an offshore discretionary trust should be taxable in the hands of Indian resident beneficiaries. As discussed in our previous hotline the Supreme Court has recently held that there should be no tax in such situations - the Tribunal would have been bound by the ruling of the highest court of India on this point.
On the point of non-disclosure itself, the ruling demonstrates the sensitivities surrounding information exchange in modern times. It is no longer appropriate, nor wise to rely upon the inaccessibility of offshore trust documents, or secrecy statutes in offshore tax havens, in an era of global information sharing.
Having said this, the Tribunal does not appear to have provided adequate basis for why, or under which provision of law, the Trust assets were added on as the undisclosed income of the Taxpayers. While section 68 of the Income Tax Act, 1961 does allow for addition of “unexplained cash credits” as income, its requirements would not be satisfied in a situation where no payments are credited to a taxpayers account, as in this case. Similarly, although there is a reference to the Trust corpus being taxed as an “undisclosed investment” of the Taxpayers, it isn’t quite clear if the Taxpayers contributed the Trust corpus.
Taxation of income in hands of beneficiary Taxpayers: Without prejudice to the above argument, it was submitted by the Taxpayers that if any tax were to be levied, it should be restricted to the income of the Trust and not the entire corpus. The Tribunal, as stated above, upheld the addition of the entire Trust corpus to the income of the beneficiary Taxpayers.
Analysis: As stated above, it is unclear why greater reliance was not placed upon the ruling of the Supreme Court in relation to offshore discretionary trusts. Based on the Supreme Court ruling, it is clear that neither the income nor the corpus of an offshore discretionary trust can be taxable in the hands of the beneficiaries prior to distribution.
- There were also procedural arguments made as regards reopening of assessments, which are not being dealt with in this news alert.
In 2011, India began to ramp up its focus on the identification and containment of black money. The Taxpayers in this case were amongst those first identified by the Government as holding secret bank accounts in Lichtenstein, and income tax proceedings were subsequently initiated against such persons. Since then, there have been year on year developments in relation to international information exchange and tax evasion, such as the release of the White Paper on Black Money in 2012, signing of multiple tax information exchange arrangements, introduction of new disclosure norms under Indian domestic laws and onerous withholding requirements for countries such as Cyprus which were unable to provide information. The new Prime Minister of India has taken on containment of “black money” as a key issue of cooperation at the G20 summit later this year, and it is evident that there will be no turning back.
While these are all positive and necessary measures, it is important to keep in mind that substantive tax issues are just as important as procedural protections in determining taxability. This ruling appears to have placed extensive emphasis on the aspect of non-disclosure by the Taxpayers, without pausing to consider whether the assets of the Trust were per se taxable in the hands of beneficiaries who did not have a specified share. This leaves open the question of whether the Tribunal ruling should be per incuriam, or not valid for failing to have considered the principles laid down by the Supreme Court in Gondal. As discussed in our previous alert, the Gondal case clearly laid down that income of a discretionary trust cannot be taxed in the hands of a beneficiary unless distributed to the beneficiary. This position in law does not change. What remains to be seen, is whether this ruling is relied upon by the revenue authorities to tax offshore trusts, thus increasing the risk of litigation.