Planning for a lasting legacy

Updated: Mar 7 2014, 08:30am hrs
Historyeither making it or making it uphas suddenly become fashionable again. Migration to trust structure seems to be the flavour of the season. Since the tax pressure on investment holding companies has become burdensome with the introduction of the dividend distribution tax and the minimum alternate tax, and given their other inherent inefficiencies, trusts have come into limelight as efficient vehicles for succession planning, consolidation of control and laying down the governance structure for the promoter family.

Given that India is producing more and more millionaires, there is arguably a case for the introduction of inheritance tax and, hence, finance minister P Chidambaram put up a proposal for the reintroduction of this tax in India. However, so far, there has been no concrete step to implement the same. Possible reasons for the reintroduction of estate duty could be revenue generation and manifestation of a socialistic objective. Historically, estate duty collections were quite small; however, with the growing fiscal deficit and socio-economic disparities in India, revenue collection as well as reduction in socio-economic inequality could be the triggers for the possible reintroduction of estate duty.

At present, India has a significant number of family-run businesses, primarily run by large families. In most cases, the third and fourth generation family members have already joined the business. Hence, succession planning should be a strong motive for the promoters and their families to realign their structures such that they have the same degree of control as a holding company and lay down future governance structure for the gen-next.

Trust is becoming an increasingly popular and useful instrument in succession planning. Most promoter-owned businesses and affluent families are migrating to a trust structure for effective wealth management and succession planning. It would be prudent to say that by setting up a trust one can bridge all the gaps, as holding family assets through a trust structure enables segregation of ownership and control, succession planning for future generations, internal dispute resolution, protection from business risks during the lifetime, etc. Further, trust can also provide for an efficient exit of a particular family/member from the business, maintenance of identified family members, say, female members, etc.

With the advantages stated above, what needs to be evaluated is how the existing structures will get migrated to trusts, considering the challenges of taxes in form of capital gains tax, general anti avoidance rules, stamp duty, deemed gift tax and regulatory hurdles of takeover code relevant for underlying listed companies, etc. Also, considering the above, the animal in the form of inheritance tax is still a surprise since there is no guidance available on how the law may get proposed.

Conceptualisation of the optimal structure depends on the facts and objectives of each family or group; however, a trust is typically settled as a specific or a discretionary trust. Trust is a pass-through entity and its taxability is determined by the way in which the trust is structured. The taxation of a family trust can either be like an individual or an association of persons (AoP) and both currently, or even in future, may not attract the minimum alternate tax or the dividend distribution tax. Trusts are fiscally transparent entities, whereby the obligation to pay tax is on the trustee (as a representative assessee). Though the income generated through the trust is taxable in the hands of the trustee, the burden of tax is effectively borne by beneficiaries of the trust.

Upon settlement of a trust, the assets transferred by a settlor/donor to a trustee are specifically exempt from capital gains tax. Also, on contribution of assets to a trust wherein the contributor and beneficiaries are close relatives, section 56 of the Income Tax Act, 1961 (assets acquired without or inadequate consideration is taxable in the hands of recipient), should not apply as the donor and beneficiaries will be eligible relatives. However, contribution of immovable properties to the trust may be liable to stamp duty.

As the trustee (except in his/her capacity as beneficiary) has no interest in the trust property and holds it for the beneficiaries, there is no tax incidence on the distribution of assets to the beneficiaries. Similarly, there is no tax on the distribution of regular income to beneficiaries. However, in order to minimise litigation related to the distribution of current year income taxed both in the hands of trustees and beneficiaries, all distribution should come from the corpus of the trust, wherein the current year income is not distributed but retained to form the corpus for distribution in subsequent years. An efficient transfer of assets to trust may possibly avoid rigours of inheritance tax.

It is important and imperative to analyse the existing structures carefully and arrive at a solution which will not only achieve the commercial, operational and emotional objectives of the promoters and their families, but will be equally effective considering the existing tax and regulatory framework and inheritance tax, if introduced in the future.

Hiten Kotak

The author is co-head, tax, and partner, M&A tax, KPMG in India. Views are personal