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In light of the recent decision of the Bangalore Tribunal on taxation of revocable transfers
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Bangalore Tribunal holds that capital contributions made by contributors to a trust shall be taxed at
the hands of the contributors as revocable transfers.
For a transfer to be revocable, the power of revocation need not be exercised by the transferor.
Power of revocation of the transferor does not have to be expressly conferred by the instrument of
transfer.
In the absence of an inter se agreement between beneficiaries determining common purpose, a
trust cannot be taxed as an Association of Persons.
To the extent that the beneficiaries are identifiable, and share of income of each beneficiary is
ascertainable through the trust deed, the trust shall be considered as determinate.
Position on determinate trust status taken by the Bangalore Tribunal is not in sync with the circular
issued by CBDT on taxation of AIFs.
Recently, the Bangalore Income Tax Appellate Tribunal (Bangalore Tribunal) in the case of DCIT v.

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India Advantage Fund VII held that income arising to a trust where the contributions made by the
contributors are revocable in nature, shall be taxable at the hands of the contributors. It was further
held that if the beneficiaries are identifiable, and share of each beneficiary is ascertainable through a
mechanism/ formula prescribed under the trust deed, the trust cannot be said to be discretionary, and
taxed at the maximum marginal rate (MMR).
The ruling comes as a big positive for the Indian fund industry. Funds, including Alternative
Investment Funds (AIFs) that are not entitled to pass through status from a tax perspective (i.e. not
covered under Section 10(23FB) of the Income tax Act, 1961 (Tax Act)) could seek to achieve a pass
through basis of tax by ensuring that the capital contributions made by the contributors is on a
revocable basis. The ruling also clarifies the basis on which a trust can demonstrate that it is
determinate. The basis seems to be different from the position taken by the tax authorities in CBDTs
Circular dated July 28, 2014.
BACKG R O UN D

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Mechanics of the Trust


Formation of the Trust: India Advantage Fund VII (the Trust) is a trust settled under the Indian
Trusts Act, 1882 under an instrument of trust dated September 25, 2006 (Trust Deed) by ICICI
Venture Funds Management Company Limited (in its capacity as the Settlor). As per the Trust
Deed, the Settlor transferred a sum of INR 10,000 to The Western India Trustee and Executor
Company Limited (the Trustee) as initial corpus to be applied and governed by the terms and
conditions of the Trust Deed.
Investment Management Agreement: The Trustee appointed ICICI Venture Funds Management
Company Limited as the investment manager of the Trust (Investment Manager).
Contributors: A Private Placement Memorandum (PPM) was issued on a confidential basis to
prospective investors for them to consider investment in the Trust. Investors (Contributors) made
contributions to the Trust fund under a specific and separate agreement (Contribution
Agreement) entered into between each Contributor individually, the Trustee and the Investment
Manager.
The Contributors were also the beneficiaries of the Trust.
Powers of the Trustee: The Trustee was empowered to call for contributions from Contributors,
which would further be invested by the Trustee in accordance with the objects of the Trust (i.e. to
make investment and achieve returns for the Contributors).

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Assessment proceedings before lower tax authorities: The Trust declared an income of INR
1,81,68,357 in its revised return of income. However, it was categorically stated by the Trust that while

in 2015

such income is being disclosed in good faith, the income shall be offered to tax by the beneficiaries

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i.e. Contributors. Consequently, the Trust declared its effective taxable income as nil. The Assessing
Officer (AO) was of the view that the Trust is in the nature of a discretionary trust taxable at MMR. The

Takes A U-Turn?

AO further went on to hold that since the Trust filed returns in the status of an Association of Persons
(AOP), and the Trust and Contributors were joined in a common purpose, the Trust is an AOP and
should be taxed at MMR accordingly.
The Commissioner for Income Tax (Appeals) reversed the order of the AO and held that the Trust is in
the nature of a revocable trust and directed the AO to treat the income of the Trust as nil. Aggrieved by
this order, the AO preferred the present appeal before the Tribunal.
IN CO ME TAX PR O VIS IO N S DEALIN G W IT H TAX AT IO N O F T R US T S
To give a brief background, the various kinds of private trusts (under Indian tax law) and their taxation
has been explained below:
Determinate trusts: In determinate trusts (where the shares of each beneficiary is determinable,
and beneficiaries are identifiable), the trustee assumes the same tax status as the relevant
beneficiary with respect to such beneficiarys share of income. The tax may be levied on the trustee
in the like manner and to the same extent as it would be levied from the relevant beneficiary2.
Discretionary trusts: In a discretionary trust, the income earned by the trust (depending on the
various streams of income) would be taxed in the hands of the trustee at the MMR (i.e. 30%)3. A
discretionary trust is one where the trustee has discretion in relation to distributions from the trust
and the beneficiarys income from the trust is not determinable till there is an actual distribution.
Revocab le transfers: In case of income arising from a revocable transfer (made to a trust), such
income is taxed at the hands of the transferor, and not the trustee 4.
Business trusts: In case of a trust (irrespective of whether discretionary or determinate) having
income in the form of profits and gains of business, the income earned by the trust shall be taxed at
MMR 5.
R ULIN G O F T HE T R IBUN AL
Validity of the Trust: The Tribunal held that the Trust was validly constituted under the provisions of
the Indian Trusts Act, 1882. It further held that the fact that the Contributors of the Trust were also the
beneficiaries, would not affect the validity of the Trust. For this purpose, the Tribunal relied upon the
ruling of the Authority for Advance Rulings in XYZ, In Re 6 where the facts were similar to the present

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case.
Applicability of revocable transfer provisions: The Tribunal concluded that sections 61-63 of the Tax
Act dealing with revocable transfers are applicable to the contributions made by Contributors. This
was based on a conjoint reading of the documents described above, and specifically the following:
Article 13 of the Trust Deed provided for termination of the Trust. Although such power was granted
to the Trustee, in the view of the Tribunal, it was a general power of revocation which was sufficient
for construing the transfer (i.e. the contributions) as a revocable transfer.
The power of revocation need not be at the instance of the Contributor (or transferor), and section
61 of the Tax Act does not contemplate such a situation. The Tribunal further held that what is
relevant is only the existence of the power to revoke a transfer, and not at whose instance such
power is exercised. The Tribunal accepted the Trusts reliance on the Supreme Courts decision in
ACIT v. Surat Art Silk Manufacturers Association 7 for this purpose.
The Tribunal also relied on the contents of the PPM which stated that the contribution made by a
Contributor was akin to a revocable transfer, and therefore income arising from such transfer shall
be taxed at the hands of the Contributor on a pro-rated basis, and not the Trust.
The Tribunal also accepted the alternative contention of the assessee Trust that the provisions of
section 63(a) of the Tax Act would render the transfers revocable. As per the PPM, if 75% of the
Contributors revoke their contribution to the Trust, the Trustee will be required to terminate the
Trust. Although such power has not been granted under the Trust Deed, the Tribunal held that it
would still be sufficient to conclude that the Contributors had deemed powers of revocation.
Reliance was placed on the Supreme Courts decision in Jyothendrasinhji v. S.I.Tripathi & Ors.8
which held that section 63(a) does not contemplate that the deed of transfer must confer the power
of revocation.
Assessment of the Trustee as representative assessee: The Tribunal noted that for provisions of
section 164(1) to apply, two aspects need to be fulfilled (i) identification of the beneficiaries and (ii)
ascertainment of the share of the income of the beneficiaries. On these two aspects, the Tribunal
held that section 164(1) was inapplicable based on the following reasoning:
Naming all beneficiaries in the Trust Deed is not required, and the fact that the Trust Deed lays
down that beneficiaries shall be investors that have made contributions to the Trust (i.e. the
Contributors) would be sufficient to identify the beneficiaries.
As regards ascertainment of share of the income of the beneficiaries, the Tribunal noted that in the
present case the shares are capable of being determined based on the pre-determined formula
prescribed under the Trust Deed. Further, the Trustee has no discretion to alter shares of the
Contributors independently. It was concluded that the ascertainment of share of the beneficiaries
was identifiable.
Assessment of Trust as an AOP: The Tribunal held that in the present case, the Contributors made
contributions to the Trust under individual Contribution Agreements. No agreement was entered inter
se between the Contributors (beneficiaries). Therefore, the AOP test of common purpose fails.
As regards the filing of returns by the Trust as an AOP, the Tribunal held that the relevant assessment
year did not contain a clause for filing return of income by a trust. The Tribunal stated that if the
argument of the tax department that all trusts are AOPs were to be accepted, it would render section
161(1) (which deals with charge of tax on trustee as representative assessee) redundant.
Income cannot be taxed doubly: The Tribunal has upheld the principle that once a taxpayer is
assessed and his assessment is completed, the tax department cannot assess the same income
for that assessment year in the hands of the other person i.e. beneficiary or trustee. As regards the
applicability of Circular 2014 regarding taxability of Alternative Investment Funds (AIFs), the Tribunal
held that the circular cannot have retrospective effect.9
AN ALY S IS
The Tribunals ruling comes as a great relief to the fund industry as it establishes fundamental
principles of fund taxation. Interestingly, while the fund taxation principles have been dealt with
extensively by the AAR in In re: XYZ, this is one of the first rulings to apply the principles of revocable
transfers to the fund taxation sphere.
Taxation of revocable transfers v. discretionary trusts: While the Tribunal examines the
applicability of revocable transfer tax provisions to a determinate trust, the same principles should
equally apply to discretionary trusts as well. The Tribunal has clearly stated that in light of the
contributions being revocable, the determinate status of the Trust need not be examined. This would
imply that once a trust has been characterized as a revocable trust, taxation would be governed by the
revocable transfer tax provisions (sections 60-63 of the Tax Act). Consequently, tax principles
otherwise applicable to business trusts or determinate trusts would no longer apply to trusts
accepting revocable transfers.
Structuring contributions as revocable transfers could also positively impact AIFs which have not been
granted tax pass through status specifically under the Tax Act (i.e. funds that are not registered under
the venture capital fund sub-category under Category I AIF and therefore will not be eligible for
exemption under section 10(23FB) of the Tax Act). Such AIFs had the risk of potentially being treated
as a business trust and taxed at MMR. Therefore, using this method, Category III AIFs such as hedge

funds can also avail of a tax pass through status by structuring capital contributions as revocable
transfers.
This technique upheld by the Tribunal could potentially be used by such funds to ensure that it may
still be possible for such pooling vehicles to get a tax pass through status that has not been explicitly
granted by the Tax Act.
Impact on 2014 Circular relating to AIFs : Earlier this year, the Central Board of Direct Taxes (CBDT)
issued Circular No. 13 of 2014 (Circular) to provide clarity on the taxation of AIFs registered under
the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012. The
Circular states that if the names of the investors or their beneficial interests are not specified in the
trust deed on the date of its creation, the trust will be liable to be taxed at the maximum marginal
rate.
As discussed in our previous hotline (that examined the implications of the Circular), this Circular has
posed problems to the domestic funds industry where AIFs often look at admitting new investors
through multiple closings, particularly in a tough fundraising environment where it is not uncommon
for some investors (particularly domestic institutions) to track the performance of an investment
manager and the funds portfolio before committing their capital or substantially increasing their
allocations. While the ruling of the Tribunal may not impact the validity of the clarification provided
under the Circular, it nevertheless offers considerable room for structuring investments into AIFs as
revocable contributions. The fund documents typically contain certain provisions including
termination, right to demand distributions (in cash and in specie) which convey the power of
revocation to various counterparties and which, if triggered, would result in the assets of the fund
being distributed pro-rata to the transferors (i.e. the investors). This should help in making a
defendable case that investments into an AIF are in the nature of revocable transfers. In fact, the
distribution waterfall clause which is a standard feature in fund documents (including the private
placement memorandum) and which empowers the trustee to make distributions to the investors on
the basis of a pre-defined sequence and order should also meet the test laid down by the Bangalore
Tribunal.
Assessment as AOP: In the past couple of years, there have been an increasing number of
assessments where the tax authorities have sought to tax an investment fund as an AOP. The
Tribunal also lends further clarity on this issue by stating that in the absence of an agreement
between the investors inter se, the common purpose test is not fulfilled.
Revocable trust as an anti-avoidance provision: Historically, the revocable transfer tax provisions
were introduced and used as a specific anti avoidance measure by the tax authorities. These
provisions were used to curb situations where the transferor transferred property to a third party, so
that income from such property was never received by him, but at the same time he retained control
over such property or its income. This ruling seems to have implicitly upheld that it is possible for the
taxpayer and not just the tax authorities, to rely on the revocable transfer provisions to his advantage.
While revocable transfers could be used to the taxpayers advantage, one would still need to be
conscious of the general anti avoidance rules that come into play next financial year (but are
applicable to structure put into place after August 30, 2010).
CO N CLUDIN G R EMAR KS
The ruling offers some degree of certainty on the rules for taxation of domestic funds that are set up in
the format of a trust by regarding such funds as fiscally neutral entities.
Globally, funds have been accorded pass through status to ensure fiscal neutrality and investors are
taxed based on their status. This is especially relevant when certain streams of income maybe tax
free at investor level due to the status of the investor, but taxable at fund level.
A circular issued by the CBDT is binding only on the tax department, and can be binding on the
taxpayer only in a situation where it is favorable to the taxpayers position.
The Circular and the ruling of the Tribunal seem to provide contradictory views on when a fund
(specifically an AIF) can be assessed on the basis of being a determinate trust. Considering that
circulars issued by the CBDT have limited binding value on taxpayers, it will be interesting to see how
things pan out in future.
Disclaimer: Although Nishith Desai Associates acted as fund counsel for the India Advantage Fund
VII, it does not it any manner impact our analysis of the ruling.

Shipra Padhi, Adhitya Srinivasan & Richie Sancheti


You can direct your queries or comments to the authors
1

ITA No.178/Bang/2012

Section 162 of the Tax Act

Section 164 of the Tax Act

Section 61 of the Tax Act

Section 161(1A) of the Tax Act

224 ITR 473 (AAR)

121 ITR 1 (SC)

201 ITR 611 (SC)

BASF (India) Ltd. & Anr. vs. W. Hasan, CIT & Ors. 280 ITR 136 (Bom)

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