15 December 2021
Family trusts have become a widely popular tool for not only succession and estate planning, but also for managing assets and investments. If deployed wisely, these trusts can prove to be an effective and tax efficient structuring instrument. However, despite the advantages offered by these family trusts, contributing or settling existing assets into such trusts may pose some challenges, especially on account of certain tax provisions. One such challenge is posed by the provisions of Section 56(2)(x) of the Indian Income-tax Act, 1961 (“IT Act”), which seeks to tax a notional income, where certain assets (such as land, securities, work of art, etc.) are transferred or settled/ contributed into a trust for no consideration or for a consideration less than the fair market value of such assets. (exempts transfer or contribution to a trust settled by an individual for the sole benefit of his/ her relatives). Recently, a similar issue came before the Mumbai ITAT, in the case of Balaji Trust[1], where the tax authorities sought to tax the gift of ‘Essar’ brand to a family trust.
Background
In the said case, the taxpayer was a private discretionary trust (“Trust”), set-up for the sole and exclusive benefit of the Ruia family members (promoters of the Essar group) of the settlor. In the year in which the trust was created, Essar Investment Limited (“EIL”), gifted the ‘Essar’ brand, including all registered and unregistered trademarks, copyrights, service marks, logos, slogans, etc., held by it to the Trust. The Trust subsequently, entered into a brand licencing agreement with the Essar group entities, on a non-exclusive basis and offered the licence fees received pursuant to such agreements, to tax. The tax officers considered receipt of copyright, trademarks and other rights as income of the Trust and sought to tax the same under the residuary head of income (‘income from other sources’), under the IT Act. The tax officer determined the value of the ‘brand’, using the discounted cash flow method and added the same to the taxable income of the Trust.
The Trust successfully appealed against the order of the tax officer, where the CIT(A) held that trademarks and copyrights received by the Trust were in the nature of a capital receipt and could not be brought to tax in the absence of any express provision to that extent. Further, the CIT(A) also rejected the argument of the tax officer that the receipt of the brand should be taxed as receipt of ‘work of art’ without any consideration under Section 56(2)(vii) of the IT Act (erstwhile provision similar to Section 56(2)(x) of the IT Act). Similarly, the CIT(A) rejected the argument that the receipt of such brand could be taxed as benefits or perquisites received pursuant to a business or profession under Section 28(iv) of the IT Act.
Decision
Receipt of Essar brand not taxable as ‘other incomes’
When the matter reached the ITAT, it was observed that in order for the receipt of brand to be subject to tax under the IT Act, it was relevant to show that either there was any element of revenue/ profit, or that such receipt was squarely covered under the definition of the term ‘income’ under the IT Act or any other specific provision. It observed that the brand, which was transferred to the Trust, did not carry any value in the books of EIL. Further, the ITAT observed that the brand was in the nature of a profit earning apparatus with which the Trust was able to generate license fee from the Essar group. Thus, the ITAT concluded that the brand was in the nature of a capital asset. Therefore, where such brand was transferred without any consideration, there was no element of income/ profit. Further, the ITAT also held that gift of such a brand did not fall within the ambit of the term ‘Income’ under the IT Act nor was it taxable under any other specific provisions of the IT Act.
Receipt of Essar brand not taxable as notional income under Section 56(2)
With respect to the applicability of Section 56(2)(vii) (erstwhile provision similar to Section 56(2)(x) of the IT Act), which provides for taxation of notional income on receipt of certain property (which inter alia includes ‘work of art’), without any consideration or insufficient consideration, it would have to be shown that the brand received by the Trust was in the nature of ‘work of art’. The ITAT clarified that the mere fact that the brand was registered as an ‘artistic work’ under the Copyright Act, 1957, would not in itself mean that the brand is also a ‘work of art’. The ITAT observed that the term ‘work of art’ was not defined in the IT Act and relied upon various judgments and dictionary meanings to conclude that a work of art must be a creation of human skill and should possess aesthetic beauty with artistic inputs. The ITAT also considered the definition of the term ‘artistic work’ under the Copyright Act, 1957, and observed that the said term also includes artistic works, irrespective of whether it possesses artistic quality or not. Thus, it held that the two terms are used in different contexts and have different scope. Basis this analysis, the ITAT held that in the case at hand, the Essar brand is neither an artistic innovation nor does it possess any artistic quality for being recognised as a work of art. Thus, it held that the Essar brand cannot be recognised as property under Section 56(2)(vii) of the IT Act and accordingly, the receipt of such brand by the Trust could not be taxed under the said Section.
Receipt of Essar brand not taxable as perquisite arising from business
The ITAT also rejected the argument of the taxpayer that the gift of brand could be taxed as benefit or perquisite, arising from business or exercise of profession under Section 28(iv) of the IT Act. The ITAT noted that the brand was gifted to the Trust on the same day it was created, therefore, it could not be said that such income/ benefit was arising out of the Trust’s business. Further, the ITAT held that, as discussed above, the receipt of brand was in the nature of a capital receipt and could not be brought to tax as busines income. Thus, the ITAT rejected the argument of the tax officer and upheld the order of the CIT(A).
Takeaways
This decision provides much needed relief and clarity to taxpayers regarding the settlement of assets into a trust. However, it would be of utmost importance to analyse the facts of each case, since factors like the nature of transaction, treatment of assets in the books and the nature of asset, etc., are likely to have an impact on taxation. Thus, it is of utmost importance that every contribution proposed to be made to a trust or any proposal to settle any asset into a trust should be vetted from a tax perspective.
Further, another important takeaway from this judgment is the applicability of the provisions of Section 56(2) to copyrights and trademarks, etc. Another noteworthy point is that, while the said judgement was rendered in the context of the erstwhile provisions of Section 56(2)(vii) of the IT Act, the discussion in the said judgement should be equally applicable to the existing provisions of Section 56(2)(x) of the IT Act. It would also be relevant to note that unlike Section 56(2)(vii), Section56 (2)(x) of the IT Act specifically exempts transfer or contribution to a trust, settled by an individual for the sole benefit of his/ her relatives. Thus providing more opportunities to structure the settlement of assets into a trust in a tax efficient manner.
While this is a welcome judgement for taxpayers, one would have to wait and see if the said decision would be challenged by the department before the High Court.
For further information, please contact:
Kunal Savani, Partner, Cyril Amarchand Mangaldas
kunal.savani@cyrilshroff.com
[1] ACIT v Balaji Trust ITA No. 5139/Mum/2017 (Mumbai ITAT)
