Indian Trust Act 1882 needs to be amended cautiously

LEGAL EYE

In a move to revitalise archaic laws, the government in a market boosting initiative recently announced a proposal to amend the Indian Trust Act, 1882 ("Act") to permit all trusts to invest in shares and bonds of listed companies.

In the current global scenario of offshore funds and investment options, the Act lags behind time. Trusts today play a significant role in most financial and legal systems and are recognised under the Hague Convention.

Under common law, a trust is an arrangement under which the settlor entrusts his property to certain persons or trustees, who become the legal owners of the trust property but hold it for the benefit of third parties, i.e. the beneficiaries. The basic constituents of a trust are transmutation of trust property, declaration of the purpose and the beneficiary.

The sole purpose of this Act was to introduce the English concept of legal and equitable ownership in estates in order to recognise the vested interests of the large body of domiciled Europeans and Eurasians. The existence and rules of "native property holders" such as Islamic waqfs and Hindu debuttar properties were preserved.

The Act extends to private trusts only, and not to public trusts. Nonetheless, Indian courts have held certain provisions applicable to public trusts as well, as principles of equity and good conscience, which includes Section 20.

The difference between a public and private trust is essentially in its beneficiaries: - A private trust's beneficiaries are a closed group, while a public trust is for the benefit of a larger cross-section having a public purpose.

Trusts are not legal entities, and are governed by the trust deed and applicable local laws. Depending on the corpus, a trust may be formed as a company or society. In case of companies, Section 25 of the Companies Act applies to non-profit making companies while institutions established for promoting religion, science etc. may also be registered as limited companies.

Under the Income Tax Act, wholly charitable and religious trusts are exempt from tax. A notified approval from the DG Income Tax Exemptions may be obtained under Section 10 (23C) for three assessment years at a time, subject to the fulfilment of certain specified conditions.

The investment restrictions under Section 20 of the Act permit trust money to be invested only in specified government securities, (including that of UK and Ireland) (sic). Since 1975, this has been extended to units issued by the Unit Trust of India.

The Income Tax Act makes it mandatory for registered trusts to invest 85 per cent of the funds received annually in the specified securities in order to avail the tax exempted status.

More than philanthropy or privacy, trusts spell big money which account for a substantial portion of trading and investment in major stock exchanges.

Complex business arrangements in the financial and insurance sectors use trusts in their structure. Asset protection is another important consideration, to move assets to a separate structure with ease to safeguard against bankruptcy.

Trust structures have evolved in offshore destinations such as Mauritius and BVI, offering investment routing to settlers with high tax domiciles, facilitating investors to lawfully avoid withholding tax or capital gains.

These tax havens have altered the traditional concept of trusts significantly, with additional protective mechanisms being internally provided, effectively extinguishing Court's role.

Even within these limitations, tax planning through public and private trusts is resorted to in India, usually for large families, even though private trusts are subjected to tax at maximum marginal rate, since trust income becomes taxable either in the hands of the beneficiary or trustee i.e. a different entity like the Hindu Undivided Family, this offers the creation of another taxable entity, claiming permissible deductions, set off's etc. combined with asset protection.

Corporates generally form their own public or charitable trusts, with similar restrictions.

And this is where the big bucks are "" with funds lying untapped or in notified securities, which the amendments intend to remove and make the stock markets boom.

But such unshackling needs to be tempered by appropriate regulations "" mutual funds in capital markets are subject to strict compliances and disclosures. Trusts also invest other persons' monies and unless adequate controls are concurrently in place, there could be mayhem in the market.

Kumkum Sen is a Partner in Rajinder Narain & Co. and can be reached at kumkumsen@rnclegal.com