Over the past few years, many Indian business families have established estate planning structures, many of which comprise one or more family trusts. The main driver for these structures would have been tax driven considerations. Under the recent Finance Bill, 2017 (Finance Bill), there was a key amendment proposed to the Income-tax Act, 1961 (IT Act), which if passed would have had a significant impact on existing and future estate planning structures – by way of a ‘gift tax’ in respect of assets received by taxpayers without consideration or for inadequate consideration (Proposed Amendment).
Subsequently, the Proposed Amendment has been further amended by the Finance Act, 2017, as passed by the Parliament on March 30th, 2017 (Finance Act). In this article, we discuss the said amendment to the gift tax regime.
Under the IT Act, gifts received by individuals and Hindu Undivided Families (HUFs), were taxed, subject to tax certain conditions and exceptions. However, other tax payers, such as unlisted companies, partnership firms and limited liability partnerships were not subject to gift tax, except if they receive shares of unlisted companies without consideration or for inadequate consideration. However, certain exceptions, namely receipts from relatives, gifts on occasion of marriage, etc had been retained.
In order to remove this disparity, the Finance Act provided that the ‘gift tax’ regime shall apply equally to all tax payers post April 1st, 2017.
Negative Impact of the Proposed Amendment
The proposal to expand the gift tax base to cover all tax payers would have had a significant impact on estate and succession planning structures especially with respect to the applicability of gift tax to private trusts. This is because, before the introduction of the Finance Bill, it was accepted that private family trusts were outside the scope of the gift tax regime.
Whilst the ‘anti-abuse’ provisions, which were otherwise only applicable in case of individuals, HUFs, firms or companies in certain cases, the Proposed Amendment extended this to cover genuine gifts and transfers essential for tax efficient succession planning. It would have amounted to the dreaded re-introduction of inheritance tax on one form of succession, which (hopefully) was not the legislative intent.
On the basis of the Proposed Amendment, and to avoid the potential impact it may have, many promoters / business families had put their structures in place before April 1st, 2017.
Sigh of relief!
Thankfully, good sense prevailed. On the basis of the representations made to the Finance Ministry by various stakeholders, the Finance Act now provides that any sum of money or any property received from an ‘individual’ by a ‘trust’ created or established solely for the benefit of ‘relative’ of the individual shall not be subject to gift tax.
The Government realised the gravity of the proposed amendment, and the need to exempt settlement of trusts from the ambit of onerous gift tax. It had earlier created serious uncertainty regarding this tax, and the applicability of the same to private trusts. However, the exception in the Finance Act now clarifies that gift tax would not be applicable in event a private trust is set up by an individual for the benefit of his/her relatives.
The appeal of private trusts
The Finance Act has allowed succession and estate planning to continue as before. By excluding a private trust set up by an individual for the benefit of his/her relatives from the purview of gift tax, private trusts are now in fact not just the ‘still go to vehicles’ but they have now become the ‘must go to vehicles’. This is because the law now clearly lays down the exception for private trusts, and hence the remote chances of dispute with tax authorities have also been eliminated.
This is a welcome amendment to the Finance Bill as it ensures that succession planning through trusts remains viable and appealing; and promoters are still able to use trusts as estate planning vehicles in the same manner as before, without any hindrance whatsoever.
The Way Forward – How would estate structures in future be impacted?
The exception introduced by the Finance Act categorically provides that only a private trust settled by an individual would be outside the purview of gift tax. Therefore, it would now be difficult to claim exemption from the applicability of gift tax if a private trust is settled by a corporate entity. This option had been explored by a number of promoters in the past, given that significant wealth was being warehoused in holding companies.
Further, in order to avail the benefit of the exception under the Finance Act, the beneficiaries of a private trust would need to be relatives of the settlor / transferor. Under the IT Act, a relative with respect to an individual would mean inter-alia the close family of the individual and/or his or his spouse’s lineal ascendants or descendants. A charity could also be considered.
In light of the same, going forward, since only individuals can settle private trusts and there are restrictions as to who can benefit from such trust structures, the same should be kept in mind whilst undertaking one’s estate and succession planning. In conclusion, it can be stated that after a scare of a few weeks, sense prevailed and the Finance Act made it possible again for individual promoters to settle trusts for their families. If this had not happened, estate planning in India would have looked very different.
* The authors were assisted by Kunal Savani, Principal Associate and Sachin Bhandawat, Associate