17 February 2021
Background:
Creation of private trusts have been considered as a popular method by rich families for succession planning. Trusts are a legal arrangement whereby assets are placed into the care of an individual who manages them for the benefit of someone else. Trust can be further classified into specific or discretionary based on the scheme of distribution of the trust fund. However, in recent times, offshore trust structures are suspected to be more commonly used as a means of money laundering than lawful tax planning. Consequently, the Income-tax Department has been unveiling various private offshore trusts and imposing tax liability on the beneficiary owners. This has led to an increase in reassessment proceedings and dissatisfaction among the residents for being subjected to wrongful tax liability. Recently, the Mumbai Income-tax Appellate Tribunal (“ITAT”) provided relief to Mr. Yashovardhan Birla and held that offshore trusts are considered to be acceptable form of tax planning and a beneficiary of an offshore discretionary trust cannot be taxed on the entire corpus fund merely because he has been provided with the power to appoint/ reappoint trustee. The case is discussed in detail below:
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Facts:
Subsequent to a search and seizure operation conducted under Section 132 of Income-tax Act, 1961 (“IT Act”) relating to Assessment Year 2008-09 to 2013-14, undisclosed gold and diamond jewellery was discovered and a notice under Section 16 of the Wealth Tax, 1957 was also served on the assessee. Pursuant to the notice, Mr. Yashovardhan Birla (the assessee) filed his Return on Wealth for AY 2008-09 on March 25, 2015 declaring his net wealth as INR 2,30,03,500 (almost six times the amount declared in the original Return of Wealth).
Additionally, based on the information received from Foreign Tax and Tax Research division of Central Board of Direct Taxes (“CBDT”), it was discovered that the assessee was a beneficiary in more than 70 offshore bank accounts and immovable properties held by offshore entities. These offshore entities hold these assets under an offshore discretionary trust. This offshore trust was created by (Late) Pratap Malpani in the year 1989 and executed by an offshore trustee, Albany Trustee Company Limited. The list of beneficiaries included viz.:(i) the Settlor, (ii) his wife, sons, their spouses and lineal descendants of the Settlor; (iii) Ashokvardhan Birla (brother-in-law of Settlor) and his wife Sunanda Birla (sister) [late parents of the Assessee], children (including, Assessee), spouses and lineal descendants; (iv) charitable organizations in India & Guernsey.
The Assessment Officer (hereinafter referred as AO) labelled the amount held in these offshore bank accounts at par with cash in hand and classified the same as unproductive asset under Section 2(ea) of Wealth Tax Act. The AO included a sum of INR 96,29,53,356/- in the net wealth of the assessee.
The Assessee filed an appeal against the order of AO to Commissioner of Income Tax (Appeal), however, it was dismissed, following which he filed an appeal to the ITAT.
Issue:
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Would having beneficial interest in offshore bank account held by offshore entities tantamount to being the ultimate beneficiary owner so as to include the amount in the net wealth of the assessee and tax the assessee accordingly?
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Is having power to appoint or reappoint trustees same as having control over the trust and trust losing its independent identity? Moreover, can the entire corpus fund of an offshore discretionary trust with offshore trustees be added in the net wealth and net income of the assessee when the assessee has never been allotted any share in the income nor has received any income from the trust?
Analysis:
The Tribunal made a comprehensive and detailed observation on the nature of the trust and recitals of the trust deed. It noted that the trust was created by Shri Pratap Malpani for the benefit of several beneficiaries including the assessee and a charitable organization. It held that the corpus of the trust cannot be considered as wealth of the assessee as:
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It is a discretionary trust under which the trustees have the absolute discretion to determine whether the amount shall be distributed to the beneficiaries or retained by the trust. Hence, the beneficiary has no vested right in the corpus but merely a hope of receiving his share.
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The assessee is not the sole beneficiary of the trust. The list of beneficiaries also included a charitable organization which means that even if other beneficiaries do not survive, the fund will still not belong to the assessee alone.
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The trust has been created by a non- resident Indian using his offshore assets and no money or contribution has been transferred from India.
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Multiple beneficiaries during their lifetime had the power to appoint the trustee in certain situation, however, merely because the assessee exercised his power of appointing trustee does not put the trust in his ultimate control.
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The trust has independent legal identity and the power of distribution of corpus still lies with the trustee and not with the assessee.
It rejected Revenue’s alternative contention of including the balance in foreign bank account as cash-in-hand under Section 2(ea) of the Wealth Tax Act, 1957. The tribunal held that “there is no room for intendment in a taxing statute.” The definition of assets under the Section only mentions cash in hand as an unproductive asset and does not provide for balance outstanding in offshore accounts as a separate category of asset or covered under an explanation to the Section. Differentiating between cash in an Indian bank account and foreign bank account, by exempting the former from wealth tax and treating the latter as cash in hand would lead to an anomaly which is not intended by the Legislation.
The reasoning provided by ITAT is also consistent with the previous Supreme Court judgments wherein the beneficiaries of an offshore discretionary trust were exempted from taxation when the income of the trust was retained by the trust and not disbursed to the beneficiaries.[1] The ITAT looked not only at the Declaration of the Trust but also the reality of how the trust has been working. It provided clarity to other issues such as:
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Assessment Officer is required to supply reasons to the assessee for initiating reassessment proceedings. Non-disclosure of reasons would infringe the assessee’s right to defend himself and vitiate the entire reassessment proceedings.
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Decision of Income Tax Settlement Commission is not binding on the Tribunal as both the cases relate to different Acts that is decision of ITSC relates to Income Tax Act while the current decision is based on Wealth Tax Act.
Conclusion:
The taxability of an offshore private trust has been a controversial issue. Even though Wealth Tax has been abolished from the financial year 2015, various assessments have been opened by the Income Tax Department suspecting money laundering being done under the veils of these trusts. Additionally, question regarding taxability of amount in an overseas discretionary trust arises under the Income Tax Act, 1961 as well. In other words, similar factual situations and arguments are witnessed in tax evasion petitions wherein the Department includes the corpus fund of such trust in the net income of the assessee and imposes tax and penalty on the amount on the grounds that this amount was not disclosed by the assessee.
For instance, Mumbai ITAT in the case of Manoj Duphelia[2], included the amount held by a discretionary offshore Ambrunova trust in the net wealth and net income of the assessee, who was mentioned as a beneficiary and denied having any knowledge of being a beneficiary in the trust. However, the ITAT failed to address in that case as to whether the Income Tax Act,1961 mandated such disclosure or not. Merely because the trust had a bank account in a bank in a jurisdiction which was infamous for being a tax haven and the assessee denied having knowledge of such trust does not infer that every account in the bank could be opened for the purposes of tax evasion. Further, a resident cannot be taxed on the corpus of the trust fund solely on the ground that he is a beneficiary. Even though there is a thin line of difference between tax planning and tax evasion, the difference cannot be ruled out and each factual scenario must be carefully examined.
Notwithstanding the fact that offshore discretionary trusts are acceptable form of tax planning, time and again, the trust structure has been used for tax evasion. The ITAT Kolkata in the White Label trust case checked the ground reality of the trust before determining whether the beneficiary is supposed to be taxed or not. All the factors: inability to prove appointment of bank as trustee, no official registration of trust under laws of Jersey, no audit report of financial statement of trust led the ITAT to conclude that genuineness of the trust structure is not verified and under the veil of an offshore trust, the assessee tried to escape taxation liability.[3] Similarly, in the Tharani case[4], the Mumbai ITAT lifted the veil off the discretionary trust. It took into all the incriminating factors such as trust was based in Cayman Islands, the trustee company was liquidated as soon as the government of India received information about the beneficiary, the assessee’s complete denial of knowledge about the existence of the trust; the assessee being the sole beneficiary of the trust, etc. It observed that “the assessee is not a public personality like Mother Terresa that some unknown person, with complete anonymity, will settle a trust to give her US $ 4 million, and in any case, Cayman Islands is not known for philanthropists operating from there.”
Hence, applying the rule of one size does not fit all, legitimacy of an offshore trust should have to be verified on a case-to-case basis and existence of incriminating evidence in the subject case could lead to levy of taxes. The taxpayer is required to come up with logical rationale of being a beneficiary of an offshore trust and why the settlor had decided to make him a beneficiary of such funds or else, he runs the risk of being liable to pay tax.
For further information, please contact:
S.R. Patnaik, Partner, Cyril Amarchand Mangaldas
srpatnaik@cyrilshroff.com
[1] Commissioner Of Wealth Tax, Rajkot v Estate Of Late Hmm Vikramsinhji Of Gondal (2014) 45 Taxmann.Com 552 (SC); H.H. Maharaja Shri Jyotindrasinhji V Acit, 326 Itr 594 (SC).
[2] 2014 Taxmanncom Mumbai Trib 52 146.
[3] Shri Som Dutt v Assistant Commissioner Of Income Tax 2015 Taxmanncom Kolkata Trib 60 59
[4] Mrs. Renu Tikamdas Tharani, Mumbai V. Dcit, Mumbai, Ita 2333/Mum/2018, Decided On July 16, 2020.
