FEBRUARY 2017

www.bdo.in

INVESTMENT TRUST NOT ASSESSABLE TO TAX AT MAXIMUM

MARGINAL RATE AS AOP

Background
Section 164(1) of the Income-tax Act,1961 (‘the Act’) provides for charge of tax where the shares of beneficiaries in a
trust are not known. According to the relevant provisions, where individual share of beneficiaries is not ascertainable on
the date of the instrument, income earned by the trust shall be chargeable in the hands of the trustee at the maximum
marginal rate. Therefore, determining the share of each beneficiary is an important aspect in the trust taxation. The
recent Karnataka High Court ruling 1 has laid down important principle in this regard, summarized as below:
The Case
India Advantage Fund-I, ICICI Emerging Sectors Fund and ICICI Econet, Internet and Technology Fund were three different
trusts (“taxpayer” or “the fund”) constituted under different instruments of trust. The trust was to facilitate investment
by the contributors (resident in India) and achieve returns for such contributors. The trust deed provided that
contributors to the fund shall also be its beneficiaries. An investor who wishes to contribute to the fund, enters into a
contribution agreement with the trust, the trustees acting on behalf of the trust and the settlor acting in his capacity as
investment manager. The beneficiaries contributed to the fund for making investments.
During the revenue audit, the taxpayer claimed that pursuant to the provisions of section 61 to section 63 of the Act
(dealing with taxation in case of irrevocable transfers), the income earned by the fund has been included in the return
of income of the beneficiaries and offered to tax directly by them.
The tax officer referred to the trust deed and observed that the shares of the beneficiaries are not specifically mentioned
therein. The fact that the trust deed provides that share of the beneficiaries would be in proportion to their investments
in the fund, do not make their share in the fund ‘determinate or known’. The tax officer further held that the taxpayer
and the beneficiaries have come together for a common purpose or common action, the object of which was to produce
income, profits and gains and therefore, it constituted an association of persons (AOP).
Order of the Tax Tribunal2
Applicability of Section 164(1):
The Tax Tribunal noted that for applicability of provisions under section 164(1), two important aspects are required to
be fulfilled:
 identifying the beneficiaries; and
 ascertaining the share of each beneficiary.

1
ITA NO.191/2015 C/W ITA NOS.446/2015, 447/2015, 448/2015, 449/2015 & 450/2015
2 ITA NO.178/BANG/2012, 177/BANG/2012, 348/BANG/2011, 475/BANG/2013,347/BANG/2011,179/BANG/2012
While evaluating the above two aspects, the Tax Tribunal held that section 164(1) was inapplicable and provided the
following reasoning in this respect:
 The trust deed lays down that beneficiaries shall be investors that have made contributions to the trust (i.e. the
contributors) and this would be sufficient to identify the beneficiaries. Therefore, naming the beneficiaries in the
trust deed is not required.
 As regards ascertaining share of income of the beneficiaries, the Tax Tribunal noted that the shares are capable of
being determined based on the pre-determined formula prescribed under the trust deed. Also, the trustee has no
discretionary right to alter shares of the contributors independently. Therefore, it was concluded that the share of
the beneficiaries was identifiable.
The Tax Tribunal further observed that contributions to the trust were made under individual Contribution Agreements.
However, no agreement was entered inter-se between the contributors (beneficiaries). Therefore, the AOP test of
‘common purpose’ does not stand true.
Question before the High Court
Identical questions were raised by the tax authorities regarding the applicability of section 164(1) of the Act.
Contentions before the High Court
Contentions of tax authorities
It was contended that the Tax Tribunal has erred in holding that the taxpayer cannot be assessed as an AOP on the basis
that the requirements of section 164(1) of the Act were not fulfilled. This is based on reasoning that the shares of the
beneficiaries were not known / indeterminate since the shares were not clearly mentioned in the trust deed. It was
argued that the shares should specifically come in existence with the quantification and it should not depend upon the
future share of the benefits or upon any contingency, such as investment through contribution. Therefore, the tax officer
was justified in invoking the provisions of section 164(1) and assessing the taxpayer at the maximum marginal rate.
Contentions of taxpayer
The taxpayer contended that so long as the trust deed gives the details of the beneficiaries and the description of the
person who is to be benefited, the beneficiaries cannot be said to be uncertain. Reliance was placed on the CBDT Circular
No.281 dated September 22,1980 which explained that for identification of beneficiaries, it is not necessary that the
beneficiary in the relevant previous year should be actually named in the trust deed. The only requirement is that the
beneficiary should be identifiable with reference to the trust deed on the date of such deed.
Further, the taxpayer also argued that it is not the requirement of law that trust deed should prescribe the percentage
share of the beneficiary, for the trust to be determinate. The fact that shares are capable of being determined based
on the provisions of the trust deed shall suffice. Even where there is an addition in the number of contributors, if the
trust deed expressly sets out the manner in which the beneficiaries are to be ascertained then it cannot be said that the
trust deed does not name the beneficiaries or that their shares are indeterminate. To substantiate the above contentions,
the taxpayer had relied on several judgements in its submission before the tax officer3.
The High Court Ruling
The High Court has upheld the decision of the Tax Tribunal in favour of the taxpayer. While holding so, the High Court
made reference to the relevant clause in the trust deed whereby the beneficiaries were defined to mean the
contributories who have made or agreed to make contributions. The High Court stated that the said clause was sufficient
to identify the beneficiaries. Regarding the ascertainment of share, the High Court held that it is sufficient that the
shares are capable of being determined based on the provisions of the trust deed, how-so-ever complex the manner of
computation may be.
BDO Comments
The CBDT Circular No. 13/2014 dated July 28, 2014 for Alternative Investment Trusts (AIF) provided that in a situation
where trust deed either does not have the name of the investors or it does not specify the beneficial interests, provisions
of section 164(1) of the Act shall apply. Though, a pass-through status is granted to Category I and Category II AIFs vide
Finance Act 2015, the applicability of provisions of section 164(1) to Category III AIFs is still debatable.
In this context, this is a welcome ruling, further confirming the principles of trust taxation as applicable to funds not
set-up as Category I and II AIFs. The principles laid down by the High Court may also be squarely applied to trusts not
set up as a fund and the existing venture capital funds operating under Venture Capital Fund guidelines of SEBI.
Interestingly, the proposed amendments to section 115BBDA of the Act vide Finance Bill 2017 provide that dividend
income shall be taxable in the hands of trusts, other than specifically excluded. In light of above ruling, question
arises as to whether such dividend income will be taxable in the hands of trusts or the beneficiaries. Further, if
dividend income is once taxed in the hands of the trust, will such income be again taxed in the hands of the
beneficiaries, needs to be evaluated.

3 Trustees of HEH Nizam’s Family (remainder Wealth) Trust 107 ITR 555 (SC); Shamaraju Trustees 56 Taxman 175 (Kar); Lakshmipat
Singhania 72 ITR 291 (SC); and Gopala Pillai A.K. 75 ITR 120 (Mad)
 If you require any further information about the material contained in the update, please get in touch with:

CONTACT US

Pranay Bhatia Kriyang Karia

Partner Associate Director
Direct Tax Direct Tax
pranaybhatia@bdo.in kriyangkaria@bdo.in
Tel: 022 3332 1682 Tel: 022 3332 1651

Bengaluru Chennai
Unit # 101, Raheja Chancery, 117/54, Floor 2, Citadel Building,
133, Brigade Road, Dr Radha Krishnan Salai,
Bengaluru 560 025 INDIA Chennai 600 004, INDIA
Tel: +91 80 4656 1300 Tel: + 91 44 4859 7026

Hyderabad Kolkata
Manbhum Jade Towers, II Floor Floor 4, Duckback House,
6-3-1090/A/12 & 13 Somajiguda, 41, Shakespeare Sarani,
Hyderabad 500082, INDIA Kolkata 700017, INDIA
Tel: +91 40 3024 2999 Tel: +91 33 4600 3505

Mumbai Pune
The Ruby, Level 9, North West Wing, Floor 6, Building # 1
Senapati Bapat Marg, Dadar (W), Cerebrum IT Park, Kalyani Nagar
Mumbai 400028, INDIA Pune 411014, INDIA
Tel: +91 22 3332 1600 Tel: +91 20 3006 4700

New Delhi - Gurgaon

The Palm Spring Plaza
Office No. 1501-08, Sector-54,
Golf Course Road, Gurgaon-122001, INDIA
Tel: +91 124 281 9000

Note: This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied
upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice.
Please contact BDO India LLP to discuss these matters in the context of your particular circumstances. BDO India LLP and each BDO member firm in India, their partners
and/or directors, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance
on the information in this publication or for any decision based on it.
BDO India LLP, a limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO
network of independent member firms.
BDO is the brand name for the international BDO network and for each of the BDO Member Firms.
Copyright ©2017 BDO India LLP. All rights reserved.

Visit us at www.bdo.in