A study conducted by Credit Suisse found that 67% out of all the listed companies in India were family-controlled. India leads the pack within Asia, with two out of every three listed companies being family-controlled. Clearly, statistics alone provide sufficient premise for aligning holding of families in the companies controlled by them.
An analysis of the present holding vehicles of promoters shows that majority of such vehicles are through holding companies. Under the existing tax and regulatory framework, such holding structures face uphill battles like cascading impact of dividend distribution tax (DDT), etc.
The buzz around reintroduction of estate duty postulates an additional basis for promoters to realign their holding vehicles for their wealth and, predominantly, their shares in operating companies. Thus, one can’t overstate the importance of realignment of holding structures of promoters from the perspective of succession and inheritance-tax planning. In light of the above, trusts could become a probable answer to address tax and regulatory hurdles and inefficiencies. Strictly from a tax perspective, holding through a trust provides benefits such as removal of the cascading effect of DDT and MAT implications on sale of shares of listed companies.
At present, from a perspective of DDT, any dividend declared by a listed company attracts an effective DDT of 20.36%. If such dividend is received by a promoter’s holding company, any further distribution to the promoters from such a company would in turn lead to a DDT leakage of 20.36% if the holding company does not hold more than 50% in the listed company or such holding company distributes dividend in the year subsequent to it receiving the same.
From the MAT perspective, if the holding company were to sell or divest the shares held by it, any capital gains arising would be exempt from being chargeable to tax provided such divestment is undertaken on floor of the stock exchange. However, despite such an exemption, such gains would still be liable to MAT at the rate of 21.34%, thereby completely erasing the apparent benefit of the exemption.
In this context, the trust structure provides an enormous advantage. Since any distribution from the trust is not subject to DDT and any capital gains arising to the trust on sale of shares of listed companies is not subject to MAT, a trust would definitely plumb the inefficient tax leakage if the promoter’s holding is through a holding company.
Apart from the tax advantages from migration to a trust structure, it also provides enormous flexibility from a regulatory and governance standpoint. From a regulatory perspective, a holding company is governed by the arduous provisions of the Companies Act, 2013/1956. The existing provisions of the law prescribe onerous responsibilities and restrictions on the holding companies such as restrictions on inter-corporate loans, transactions with related parties, further issuance of capital, tedious compliance and disclosure obligations under the securities laws to the Securities and Exchange Board of India and stock exchanges, and so on and so forth. From a governance viewpoint, the role and responsibilities of the board of directors of the holding companies are also controlled by the rigorous provisions of the Companies Act 2013/1956. Further, since majority of the assets of the holding company would be in the form of investment in operating companies and majority of its income would be in the form of dividend, such a holding company would be deemed to be a non-banking financial company (NBFC). Consequently, it would have comply with the rigorous norms prescribed by RBI for NBFCs.
As a complete antithesis, a trust structure provides significantly more regulatory and compliance flexibility. Fundamentally, a trust is governed by its own charter known as the trust deed. The controlling body of the trust are the trustees whose powers and duties are governed by the trust deed. Further, any distribution, and the manner thereof, to the beneficiaries, being the promoters, is also governed by the trust deed. The trust deed could also have provisions on manner of decision making amongst the trustees, succession of trustees, separation of management of the listed companies from its ownership, conflict resolution through mediation and arbitration, and the like. While the provisions of the trust deed would in turn be governed by the various laws, the trust deed provides a flexible framework for acting as a holding vehicle for the wealth of the promoters.
Succession planning through trusts can also be a possible solution for estate duty, if reintroduced. With all the aforementioned advantages, many business houses are evaluating migration to a trust. The time is ripe to realign the promoter structures and transition from the inefficient holding companies to trusts in order to gain advantages in terms of mitigating tax inefficiencies, increasing regulatory and compliance flexibility and act as a seamless vehicle for passing the family baton to successive generations.
The author is Hiten Kotak, M&A Tax Leader, PwC India
With contributions from Pawan Poddar, Director and Binoy Parikh, AM, M&A Tax, PwC India