I recently shifted my residence to Dubai. I am a joint beneficiary with my brother in a trust arranged by my father in India. The trust owns a residential house and some fixed deposits (FDs). Both my parents and my brother continue to live in India. Last month, the trust sold the house and invested the sale proceeds in a new home. We learned that since the house was owned by the trust and the trust purchases the new property, it cannot enjoy the tax exemption upon reinvestment that would otherwise be available to an individual. Is this true?
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Because the beneficiaries’ shares in the trust can be determined, the trust qualifies as a specific trust. In addition, because your father irrevocably placed the property into the trust, it is classified as a specific irrevocable trust. This distinction is important because the Income Tax Act, 1961 (ITA) applies different tax treatments to private, revocable and irrevocable trusts, as well as to specific and discretionary trusts.
Read this | Tax Exemption for Trusts: Expense in India or Benefit in India?
Although the ITA does not explicitly define the status of a private trust, courts have clarified this in several cases. A trust is a legal obligation and not a separate legal entity. Under the ITA, trustees of a private trust act as representative assessors. For specific trusts, trustees are assessed in their own names for income expressly earmarked for the beneficiaries. This income is taxed “in the same manner and to the same extent” as directly from the beneficiaries.
In Commissioner of Wealth Tax, AP versus trustees of HEH Nizam’s family (Remaining wealth) Trust [1977] 108 ITR 555 (SC), the Supreme Court clarified that the assessment of the trustee reflects the status of the beneficiary. The trustee’s tax liability is equivalent to what each beneficiary would owe if assessed directly. In this case, since the status of the trustee corresponds to that of the beneficiaries, the trustee would be assessed as an individual, and your status as a non-resident would not change this conclusion.
The ITA allows taxation of income either in the hands of the trustee (as representative assessor) or directly in the hands of the beneficiaries. In your case, the capital gain from the sale of the property can be valued in the hands of the trustee or divided between you and your brother as beneficiaries.
Importantly, the reinvestment exemption under section 54 of the ITA can still be claimed. Regardless of whether the tax is levied on the trustee in a representative capacity or directly on you and your brother as individuals, the exemption applies.
The Income Tax Department could challenge the exemption under Section 54 on the ground that the reinvestment was made by the trustee and not directly by the beneficiaries. However, judicial precedents have shown that eligibility for relief under Article 54 does not depend on the source of the funds or the entity making the reinvestment. You can substantiate your claim on these statements.
Harshal Bhuta is a partner at PR Bhuta & Co. Chartered accountants
