On February 1st, 2017, the Indian Finance Minister, Mr. Arun Jaitley, presented the Government of India’s annual financial statement for 2017-18, commonly referred to as the Union Budget. As is tradition, the Budget was accompanied by proposals to amend the direct tax regime contained in the Indian Income-tax Act, 1961 (IT Act).
Two proposed amendments, in particular, will cause considerable angst to estate practitioners across the country as they are likely to have a significant impact on estate planning structures commonly used in India. Ultimately, it will be Indian families looking at undertaking their succession planning, who will suffer when dealing with the consequences of such amendments.
The first proposed amendment relates to a ‘gift tax’ in respect of assets received by taxpayers (assessees) without consideration or for inadequate consideration. The other pertains to an ‘additional dividend tax’ on dividend income received from companies in which the taxpayer holds shares.
Notably, neither of these proposed amendments introduces a new levy. Instead, they attempt to plug gaps in the IT Act, which presently exclude certain assessees from the ambit of existing taxes. But if these proposed amendments are passed in their current form – as it is likely they will be – they are expected to considerably reduce the fiscal efficiency, and consequently attractiveness, of trusts as estate planning tools.
Taxing of gifts
Indian law permits gifts (that is, transfers made without monetary consideration) of both moveable and immoveable property to be made voluntarily by one person to another. Inter vivos gifts have been a popular mode of estate planning in recent years, with careful consideration being given to both the donor and the donee from a legal and tax perspective.
Gifts were first taxed in India under the Gift Tax Act of 1958. This tax regime continued for more 40 years, till it was thankfully abolished in 1998 for being unsuccessful in curbing tax evasion and avoidance.
At the same time, to ensure that there were no leakages of income-tax revenue, it was proposed that gifts would be taxed under the IT Act itself in the hands of the recipients. However, owing to public representations, the proposal to tax gifts as income was dropped, and India remained a gift-tax neutral jurisdiction till the tax was reintroduced, albeit in a different form, in the IT Act in August 2004.
In the past decade, the ‘gift tax’ provisions of the IT Act have undergone multiple amendments – with each amendment seeking to modify the ambit of the provisions to include various kinds of transfers, assets and assessees.
In its present form, the ‘gift tax’ regime in the IT Act is found in two provisions, one wide and the other narrow, depending on the nature of the tax payer. Individuals and Hindu Undivided Families (a form of family holding structure created by law and unique to Hindu families in India) are subject to a wider form of tax, which taxes any sum of money or property received without consideration or for inadequate consideration (in excess of the specified limit of INR 50,000). This levy is subject to certain exceptions, namely receipts from relatives, gifts on occasion of marriage, etc.
On the other hand, some other tax payers such as certain unlisted companies, partnership firms and limited liability partnerships are taxed only if they receive shares of unlisted companies without consideration or for inadequate consideration (in excess of the specified limit of INR 50,000). All other transfers to such assessees are tax-free in the hands of the recipient.
Given the disparity in the two taxing provisions, while certain structures could avoid the ‘gift tax’ – for instance, by gifting shares of listed companies to personal holding vehicles in the form of limited liability companies or partnerships –other transactions / structures would attract it.
The proposed amendments to the IT Act now seek to remove this disparity and ensure that the ‘gift tax’ regime (or the anti-abuse provisions, as the Finance Minister refers to them) apply equally to all tax payers. Should these amendments be enacted, then the existing ‘gift tax’ provisions will become non-operational post April 1st, 2017 and a new provision will be introduced in the IT Act, which will treat all assessees at par.
As per the new provision, if any person receives from any one or more persons – without distinction – any sum of money – or again without distinction – property without consideration or for inadequate consideration (in excess of INR 50,000), on or after April 1st, 2017, he/it will be liable to pay tax on such receipt. This chargeability will, however, be subject to exceptions that are similar to the existing exceptions (which are relevant for contributions to private trusts).
In this, while the proposed provisions will bring about clarity and consistency in taxation, there is a degree of uncertainty as to how they will apply to private discretionary trusts.
It can be argued that as trusts are ‘representative assessees’ of the beneficiaries, transfer of trusts ought to be covered under one or more of the exceptions to the gift tax provisions, such as gifts from any relative, or those in contemplation of death of the donor, etc. The counter view that may emerge is that gifts to discretionary trusts would be covered under the gift tax regime because although trusts are not expressly identified within the definition of ‘person’ under the IT Act, some tax rulings have treated discretionary trusts as ‘individuals’ and therefore, ‘persons’ under the IT Act.
Gifts to charitable trusts and those under a Will to testamentary trusts, however, continue to be specifically exempt.
Additional dividend tax
Profits distributed by a domestic company to its shareholders in the form of dividend are subject to dividend distribution tax (DDT) in India. DDT is payable by the company declaring the dividend. Till last year, dividends subject to DDT were tax exempt in the hands of the recipient.
In 2016, a new levy taxing dividends paid, declared or distributed by a domestic company after April 1st, 2017, at the rate of 10%, was introduced in the IT Act. Colloquially, this tax is called an ‘additional dividend tax’ because it is in addition to DDT already payable by the company declaring the dividend. Unlike DDT, though, additional dividend tax is payable by the person receiving the dividend.
Interestingly, when additional dividend tax was brought into the taxing statute last year, it was restricted to dividends received by individuals, Hindu Undivided Families, domestic partnership firms and LLPs. The levy did not apply to other tax payers, including companies.
With a view to ensure horizontal equity among tax payers deriving income from dividends, it is now proposed that the IT Act will be amended so as to make additional dividend tax payable by all resident assessees except domestic companies and charitable institutions.
This amendment will take effect from April 1st, 2018. Dividends lower than INR 1 million will be exempt.
Thus, a view may be taken that private trusts will now be subject to additional dividend tax on dividends received by them. In the case of a determinate trust, the trust may get the benefit of INR 1 million for each beneficiary, but the same may not be available in case of a discretionary trust.
If the Indian judicial authorities uphold the interpretation that this tax applies to discretionary trusts if and when a case is filed in this regard, it would have an impact on the myriad family trusts, which have been established by promoters of large Indian listed companies to hold significant shareholding. That said, the position of such individuals would not be any different than if they had held these shares individually instead of through trusts.
At present, the proposed tax amendments have been introduced in a Bill that has been tabled before the Indian Parliament. It remains to be seen whether the Bill is enacted in its existing form or is modified post Parliamentary debates and public representations to the government. In either event, Indian and India-facing estate practitioners should be mindful of these provisions, and the interpretation of these in their applicability to private trust structures.