The Income Tax Appellate Tribunal (ITAT) Chennai has ruled that equity shares transferred to a private trust set up exclusively for the benefit of relatives are not taxable under Section 56(2)(x) of the Income Tax Act.
“The ITAT has effectively recognised that where a trust is created exclusively for the benefit of relatives, contributions to such a trust can be treated as indirect gifts to relatives and therefore fall within the exemption under Section 56(2)(x),” an tax expert said.
What is private trust?
A private trust is a legal arrangement in which an individual, known as the settlor, transfers assets to another person or entity, called the trustee, who manages them for the benefit of designated beneficiaries. Establishing a private trust formalises this transfer and ensures that the assets are used solely for the benefit of the intended individuals, in accordance with the settlor’s wishes.
“A private trust helps in planned wealth transfer, avoids disputes and allows control over how and when beneficiaries receive assets,” another tax expert said.
What is the case?
The case is related to a private trust created by an individual, Srinivasan, in September 2021. During the same year, he transferred equity shares worth around Rs 15.78 crore to this trust. The trust treated this transfer as tax-free and did not pay tax on it, claiming that it falls under the exemption provided in Section 56(2)(x) of the Income Tax Act, which allows tax-free transfers to trusts set up for relatives.
However, the Income Tax Department disagreed. The Assessing Officer argued that the trust was not exclusively for relatives because the trust deed allowed the possibility of adding other entities (even if controlled by relatives) as beneficiaries. Based on this, the officer treated the value of shares as taxable income under ‘income from other sources’ and added Rs 15.78 crore to the trust’s income.
The trust challenged this decision, but even the Commissioner of Income Tax (Appeals) upheld the tax addition. The matter then went to the Income Tax Appellate Tribunal (ITAT), Chennai. During the hearing, it was highlighted that a revised trust deed clearly restricted the beneficiaries only to relatives, removing earlier ambiguities.
The ITAT ruled in favour of the trust. It held that what matters is the actual purpose and structure of the trust, not hypothetical possibilities in the drafting. Since the trust was genuinely created for the benefit of relatives, the transfer of shares qualified for exemption under Section 56(2)(x).
What are the other tax benefits of a private trust?
A private trust also gives several tax benefits beyond just the exemption under Section 56(2)(x).
When a person or HUF transfers assets into an irrevocable trust, it is not treated as a sale, so no capital gains tax is charged (as per Section 47(iii)). This helps in moving and managing wealth within a trust without immediate tax impact.
Also, the trust takes over the original purchase cost and holding period of the asset (under Sections 49 and 2(42A)). This means that when the trust later sells the asset, it can claim indexation benefits from the original purchase date and may qualify for long-term capital gains tax.
“On the income side, a specific trust permits taxation in the hands of the trustee at the slab rates applicable to each beneficiary under Section 161, facilitating legitimate income distribution across lower tax brackets. Even in discretionary trusts, judicial authority has clarified that preferential rates applicable to particular heads of income, such as long-term capital gains, are not overridden by the maximum marginal rate,” another tax expert said.
How to form a private trust?
Setting up a private trust involves identifying the settlor, trustee, and beneficiaries, followed by drafting a trust deed that clearly lays out the purpose of the trust, the powers of the trustee, and the mechanism for distribution of assets. “Once the structure is defined, assets are transferred into the trust, and the trust may need to be registered depending on the nature of assets and applicable legal requirements. The most critical aspect, however, is careful drafting and clarity of intent, as poorly structured trusts often lead to legal complications and adverse tax consequences,” another tax expert said.
