3 min read.Updated: 08 Jun 2021, 06:01 AM ISTAbhishek Tripathi
It is important to take legal and tax advice before succession planning
Many people have been compelled to think about estate management (in the event of their death) by the unanticipated losses brought about by covid. Although a Will has been the most popular instrument for succession and estate planning, family trusts too have been used from time to time.
In a Will, a person may specify the manner in which her properties shall be distributed after her death. Family trusts are set up as private trusts under the Indian Trusts Act, 1882, either for specified persons (specific trusts), or a class of persons who are not specifically named (discretionary trusts). Properties are transferred to the trust by the settlor, which are managed by the trustee(s) for the benefit of the beneficiaries.
In the 1980s, separate tax slabs were provided for family trusts; further, devolution of estate among heirs also attracted estate duty. This made family trusts attractive as instruments for tax structuring. Over the years, tax laws have been amended. Now, discretionary trusts are taxed at the maximum marginal rate, while specific trusts are taxed at the same rates as the beneficiaries. These amendments coupled with the abolition of estate duty have eroded the tax benefits that family trusts offered.
Despite the fact that there are no obvious tax benefits, why have family trusts as instruments of succession planning not disappeared? First, there have been periodic rumours that estate duty may be brought back. This has led to many people considering setting up family trusts to avoid the outflow of estate duty. Second, family trusts have traditionally been seen as a good way to settle the distribution of assets during the lifetime of the person settling such a trust. Trust mechanism also allows the settlor to ensure that the management of the assets remain with the trustees, while the income may be divided among the beneficiaries. This is particularly advantageous if the beneficiaries are of a young age or have lived experience of disability or are otherwise vulnerable.
In many business families, family trusts may also provide continuity to businesses and prevent disruption due to subsequent feuds after the demise of the head of the business/ family. Settling assets through a trust may allow the settlor to ring-fence the assets under trust from potential liabilities or insolvency proceedings. The possibility of insolvency may prompt many persons to take recourse to setting up trusts to provide for their heirs. However, it needs to be borne in mind that insolvency law provides for a clawback of assets transferred by the person in insolvency, if such transfer has taken place in the two years preceding the initiation of insolvency. Further, any assets acquired through fraud would not be allowed to be ring-fenced and may be subject to seizure and attachment.
The transfer of immovable property to a trust entails the payment of significant stamp duty, which increases the cost of setting up such trusts. For the transfer of the assets to a trust to remain tax-free, the beneficiaries must be the specified relatives of the settlor, else the value of the entire asset transferred to the trust shall become income of the trust. The relatives who may be beneficiaries include the spouse, siblings and their spouses, spouse’s siblings and their spouses, lineal ascendants and descendants, such as father, grandfather, children and grandchildren, and their spouses, and the lineal ascendants and descendants of the spouse and their spouses. Moreover, the income of the trust to the extent it is for the benefit of the spouse and minor children may be clubbed with the income of the settlor.
Wills remain more popular than family trusts. The reason lies in the potential stamp duty implications when assets are to be settled in a family trust as well as tax provisions on clubbing of income. Devolution of assets among legal heirs through a Will does not result in tax implication on the legal heirs. Since the Will comes into effect only upon death, the person retains control over the assets and may also be able to alter the manner and the extent of devolution during his/her lifetime.
The making of a Will requires the maker, also called the testator, to be of sound mind, and it needs to be attested. A Will can also be registered to minimize legal challenges to the execution, although an unregistered Will is also enforceable. The relative ease and lack of formalism required for making a Will make it a preferred mode of succession planning as setting up a trust would entail engaging a lawyer to settle and register the trust.