Why trust laws need a makeover

Among the other issues that trusts face its corpus, tax status and withdrawal are also open to interpretation. 

The Free Dictionary describes the term corpus as "the capital or principal amount, as of an estate or trust”. In the normal course, the corpus of a trust is sacrosanct and cannot be touched unless the settlors have given directions to the contrary. Therefore, if settlors make any contribution in the form of shares and the income arising out of these shares is intended to be used for charitable objectives, the trustees cannot liquidate this investment and the law should not override such stipulations unless there are cogent reasons for doing so. Therefore, if Tata Trusts are holding on to shares they are doing so at the express wish of the settlors. This practice could still be a case of a technical violation of law, but it does not pass the litmus test of rationality.

Tax exemption: It appears that the trusts could not treat dividend income as exempt following the amendment of the IT Act in October 2014 (effective April 2015) relating to general exemption provisions applicable to trusts and cancellation of registration of trusts in case of non-compliance. 

The Tata Trusts deriving the major chunk of their income from dividend were hit badly. And it is at this stage that the trusts made their biggest mistake of seeking cancellation rather than questioning the logic of amendment. The amendment begs the question: Was this intentional or unintentional? Logical or illogical? Nothing could be more illogical than the proposed amendment. Why?

While the trust does not pay any tax on its income derived in form of interest, which is not taxed at any stage, it would be required to pay tax on dividend income, which is already taxed twice in form of corporate tax and dividend distribution tax! Keeping in mind the public good that trusts are serving, this change was not at all in consonance with objective of exemptions given to trusts. Therefore, the trusts should have sought clarification and requested exemption because it appears that the provision was not well thought out -- unless the objective was to ensure that trust would only invest in government securities. Could this have been done? Probably not, since it would amount to a situation that government was using tax provisions to force trusts to invest in its securities. In such cases, would dividend received from public sector companies be taxed or exempt?

Voluntary withdrawal: In a knee-jerk reaction to tax changes, finding that a trust would be a loser from all sides if the status quo continued, trusts decided to voluntarily surrender their exemptions and registration in early 2015, rather than fight and test waters with the authorities and later possibly with the courts. 

The present imbroglio is the problem child of tax amendments and the trusts’ decision to voluntarily surrender its exemption. Without going into detail, suffice it to say that if exemption and registration are treated as a favour by the tax authorities, the law cannot force anyone to avail of the favour. 

Thus, the argument of the trusts that they surrendered their registration and exemption, and such surrender be recognised as complete from the day the application was made has merit. There can’t be even an issue that application was incomplete, because the application was to surrender a notional benefit and not to seek something new. It is not prepayment of a term loan, which needs the lenders’ approval. The authorities also cannot make the case that they have fundamental and unquestionable right to delay taking a decision and the burden of delay is to be borne by the applicant. 

The way forward: Having come to this stage, unless the tax authorities take a  suo motu decision to review the tax laws and its inconsistency with objectives, a legal remedy is the only option. And in times like this that the trusts would be missing a legal luminary such as the late Nani A Palkhivala.

A relook at the laws related to trusts is vital because the laws are archaic, without any justifiable rationale, are not contemporary and are hurting the objective of public good. Those violations that occur must be addressed and punished adequately, with individuals at fault penalised rather than the trusts, unless there is a doubt about the charitable activities of the trusts. While the jury is still out, very few Indians would doubt the charitable intentions and activities of the Tata Trusts. (Concluded)

Read the first part here.
The author is founder and managing director of Stakeholders Empowerment Services