All about Setting up a Trust in India: A Guide

The Author, Sumedha Sindhu is a Senior Partner at Lexidem & Rathi. She has done her LLM from National University of Singapore in International Dispute Resolution.

Introduction:

A private trust is a trust that is constituted for the benefit of one or more individuals who are, or within a given time maybe, definitely ascertained. Private Trusts are regulated by the Indian Trusts Act 1882. These trusts may be created inter vivos or by will.

Relevant Provisions

1. Trust is defined under Section 3 of the Indian Trusts Act, 1882 (“hereinafter referred to as ITA”): (Interpretation Clause)

“A "trust" is an obligation annexed to the ownership of property, and arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him, for the benefit of another, or of another and the owner:

"author of the trust": "trustee": "beneficiary": "trust property": "beneficial interest": "instrument of trust":

the person who reposes or declares the confidence is called the "author of the trust": the person who accepts the confidence is called the "trustee": the person for whose benefit the confidence is accepted is called the "beneficiary": the subject matter of the trust is called "trust-property" or "trust-money": the "beneficial interest" or "interest" of the beneficiary is his right against the trustee as owner of the trust property; and the instrument, if any, by which the trust is declared is called the "instrument of trust";

"breach of trust": a breach of any duty imposed on a trustee, as such, by any law for the time being in force, is called a "breach of trust".

"registered": and in this Act, unless there be something repugnant in the subject or context, "registered" means registered under the law for the registration of documents for the time being in force.

"notice": a person is said to have "notice" of a fact either when he actually knows that fact or when, but for wilful abstention from inquiry or gross negligence, he would have known it, or when information of the fact is given to or obtained by his agent, under the circumstances mentioned in the Indian Contract Act, 1872 (9 of 1872), section 229.

Expressions used herein and defined in the Indian Contract Act, 1872 (expressions defined in Act 9 of 1872), shall be deemed to have the meanings respectively attributed to them by that Act.”

2. Trust of Immovable Property: Section 5

No trust in relation to immovable property is valid unless declared by a non-testamentary instrument in writing signed by the author of the trust or the trustee and registered or by the will of the author of the trust or of the trustee.

Trust, of movable property: No trust in relation to movable property is valid unless declared as aforesaid, or unless the ownership of the property is transferred to the trustee.

These rules do not apply where they would operate so as to effectuate a fraud.

3. Creation of Trust: Section 6

A trust is created when the author of the trust indicates with reasonable certainty by any words or acts

(a) an intention on his part to create thereby a trust,

(b) the purpose of the trust

(c) the beneficiary, and

(d) the trust – property, and (unless the trust is declared by will or the author of the trust is himself to be the trustee) transferred the trust – property to the trustee.

4. Who may be beneficiary: Section 9

Every person capable of holding property may be a beneficiary. 

5. Trustee to Execute Trust: Section 11

The trustee is bound to fulfil the purpose of the trust, and to obey the directions of the author of the trust given at the time of its creation, except as modified by the consent of all the beneficiaries being competent to contract.

Where the beneficiary is incompetent to contract, his consent may, for the purposes of this section, be given by a principal civil court of original jurisdiction.

Nothing in this section shall be deemed to require a trustee to obey any direction when to do so would be impracticable, illegal or manifestly injurious to the beneficiaries.

Explanation: Unless a contrary intention be expressed, the purpose of a trust for the payment of debts shall be deemed to be (a) to pay only the debts of the author of the trust existing and recoverable at the date of the instrument of trust, or, when such instrument is a will, at the date of his death, and (b) in the case of debts not bearing interest, to make such payment without interest.

Rights and Powers of Trustees

6. Right to Title Deed: Section 31

A trustee is entitled to have in his possession the instrument of trust and all the documents of title (if any) relating solely to the trust – property.

7. Right to Reimbursement of expenses: Section 32

Every trustee may reimburse himself, or pay or discharge out of the trust – property, all expenses properly incurred in or about the execution of the trust, or the realization, preservation or benefit of the trust – property, or the protection or support of the beneficiary.

If he pays such expenses out of his own pocket he has a first charge upon the trust – property for such expenses and interest thereon, but such charge (unless the expenses have been incurred with the sanction of a principal civil court of original jurisdiction) shall be enforced only by prohibiting any disposition of the trust – property without previous payment of such expenses and interest.

If the trust property fail, the trustee is entitled to recover from the beneficiary personally on whose behalf he acted, and at whose request, expressed or implied, he made the payment, the amount of such expenses.

Right to be recouped for erroneous overpayment.

Where a trustee has by mistake made an over – payment to the beneficiary, he may reimburse the trust property out of the beneficiary’s interest. If such interest fail, the trustee is entitled to recover from the beneficiary personally the amount of such overpayment.

8. Right to indemnity from gainer by breach of trust: Section 33

A person other than a trustee who has gained an advantage from a breach of trust must indemnify the trustee to the extent of the amount actually received by such person under the breach, and where he is a beneficiary the trustee has a charge on his interest for such amount.

Nothing in this section shall be deemed to entitle a trustee to be indemnified who has, in committing the breach of trust, been guilty of fraud.

1. Right to apply to Court for opinion in management of Trust property: Section 34

Any trustee may, without instituting a suit, apply by petition to a principal Civil Court of original jurisdiction for its opinion, advice or direction on any present questions respecting the management or administration of the trust – property other than questions of detail, difficulty or importance, not proper in the opinion of the Court for summary disposal.

A copy of such petition shall be served upon, and the hearing thereof may be attended by, such of the persons interested in the application as the Court thinks fit.

The trustee stating in good faith the facts in such petition and acting upon the opinion, advice or direction given by the Court shall be deemed, so far as regards his own responsibility, to have discharged his duty as such trustee in the subject – matter of the application.

The costs of every application under this section shall be in the discretion of the Court to which it is made.

10. Right to Settlement of Accounts: Section 35

When the duties of a trustee, as such, are completed, he is entitled to have the accounts of his administration of the trust – property examined and settled; and, where nothing is due to the beneficiary under the trust, to an acknowledgement in writing to that effect.

11. Power to sell in lots and either by public auction or private contract: Section 37

Where the trustee is empowered to sell any trust – property, he may sell the same subject to prior charges or not, and either together or in lots, by public auction or private contract, and either at one time or at several times, unless the instrument of trust otherwise directs. 

         L. Power to sell under special conditions – Power to buy in and re – sell: Section 38

The trustee making any such sale may insert such reasonable stipulations either as to title or evidence of title, or otherwise, in any conditions of sale or contract for sale, as he thinks fit; and may also buy in the property or any part thereof at any sale by auction, and rescind or vary any contract for sale, and re-sell the property so bought in, or as to which the contract is so rescinded, without being responsible to the beneficiary for any loss occasioned thereby.

Time allowed for selling trust-property. - Where a trustee is directed to sell trust-property or to invest trust-money in the purchase of property, he may exercise a reasonable discretion as to the time of effecting the sale or purchase.

       M. Power to convey: Section 39

For the purpose of completing any such sale, the trustee shall have power to convey or otherwise dispose of the property sold in such manner as may be necessary.

14. Power to vary investments: Section 40

A trustee may, at his discretion, call in any trust-property invested in any security and invest the same on any of the securities mentioned or referred to in section 20, and from time to time vary any such investments for others of the same nature:

Provided that, where there is a person competent to contract and entitled at the time to receive the income of the trust-property for his life, or for any greater estate, no such change of investment shall be made without his consent in writing.

• Power to apply property of minors, etc. for their maintenance, etc.: Section 41

Where any property is held by a trustee in trust for a minor, such trustee may, at his discretion, pay to the guardians (if any) of such minor, or otherwise apply for or towards his maintenance or education or advancement in life, or the reasonable expenses of his religious worship, marriage or funeral, the whole or any part of the income to which he may be entitled in respect of such property; and such trustee shall accumulate all the residue of such income by way of compound interest by investing the same and the resulting income thereof from time to time in any of the securities mentioned or referred to in section 20, for the benefit of the person who shall ultimately become entitled to the property from which such accumulations have arisen:

Provided that such trustee may, at any time, if he thinks fit, apply the whole or any part of such accumulations as if the same were part of the income arising in the then current year.

Where the income of the trust-property is insufficient for the minors maintenance or education or advancement in life, or the reasonable expenses of his religious worship, marriage or funeral, the trustee may, with the permission of a principal Civil Court of original jurisdiction, but not otherwise, apply the whole or any part of such property for or towards such maintenance, education, advancement or expenses.

Nothing in this section shall be deemed to affect the provisions of any local law for the time being in force relating to the persons and property of minors.

16. Power to compound etc.: Section 43

Two or more trustees acting together may, if and as they think fit:

(a) accept any composition or any security for any debt or for any property claimed;

(b) allow any time for payment of any debt;

(c) compromise, compound, abandon, submit to arbitration or otherwise settle any debt, account, claim or thing whatever relating to the trust; and

(d) for any of those purposes, enter into, give, execute and do such agreements, instruments of composition or arrangement, releases and other things as to them seem expedient, without being responsible for any loss occasioned by any act or thing so done by them in good faith.

The powers conferred by this section on two or more trustees acting together may be exercised by a sole acting trustee when by the instrument of trust, if any, a sole trustee is authorized to execute the trusts and powers thereof.

This section applies only if and as far as a contrary intention is not expressed in the instrument of trust, if any, and shall have effect subject to the terms of that instrument and to the provisions therein contained.

This section applies only to trusts created after this Act comes into force.

17. Power to several trustees of whom one disclaims or dies: Section 44

When an authority to deal with the trust-property is given to several trustees and one of them disclaims or dies, the authority may be exercised by the continuing trustees, unless from the terms of the instrument of trust it is apparent that the authority is to be exercised by a number in excess of the number of the remaining trustees.

18. Suspension of trustees powers by decree: Section 45

Where a decree has been made in a suit for the execution of a trust, the trustee must not exercise any of his powers except in conformity with such decree, or with the sanction of the Court by which the decree has been made, or, where an appeal against the decree is pending, of the Appellate Court.

19. Trustee cannot renounce after acceptance: Section 46 

A trustee who has accepted the trust cannot afterwards renounce it except (a) with the permission of a principal Civil Court of original jurisdiction, or (b) if the beneficiary is competent to contract, with his consent, or (c) by virtue of a special power in the instrument of trust. 

20. Trustee cannot delegate: Section 47

A trustee cannot delegate his office or any of his duties either to a co-trustee or to a stranger, unless (a) the instrument of trust so provides, or (b) the delegation is in the course of business, or (c) the delegation is necessary, or (d) the beneficiary, being competent to contract, consents to the delegation.

21. Co – trustees cannot act singly: Section 48

When there are more trustees than one, all must join in the execution of the trust, except where the instrument of trust otherwise provides.

5. Control of discretionary power: Section 49

Where a discretionary power conferred on a trustee is not exercised reasonably and in good faith, such power may be controlled by a principal Civil Court of original jurisdiction

23. Trust how Extinguished: Section 77

A trust is extinguished:

1. When its purpose is fulfilled; or
2. When its purpose becomes unlawful; or
3. When the fulfilment of its purpose becomes impossible by destruction of the trust – property or otherwise; or
4. When the trust, being revocable, is expressly revoked.
5. Revocation of trust: Section 78

A trust created by will may be revoked at the pleasure of the testator. A trust otherwise created can be revoked only –

1. Where all the beneficiaries are competent to contract – by their consent;
2. Where the trust has been declared by a non – testamentary instrument or by word of mouth – in exercise of a power of revocation expressly reserved to the author of the trust; or
3. Where the trust is for the payment of the debts of the author of the trust, and has not been communicated to the creditors – at the pleasure of the author of the trust.
4. Revocation not to defeat what trustees have duly done: Section 79

No trust can be revoked by the author of the trust so as to defeat or prejudice what the trustees may have duly done in execution of the trust.

Rules and Procedures Regarding Setting up a Trust

• The creation and operation of a Trust is governed by the Indian Trusts Act, 1882. The Indian Trust Act, 1882 must be read together with the relevant Tax, Real Estate and Securities Law for creating a valid private Trust. 

Requisites of a Proper trust

• Trust Deed
• Author/ Settlor
• Lawful Purpose
• Beneficiaries
• Description of Property Settled – Immovable / Moveable
• Trustees

Reasons for setting up a Trust:

• Protection of Assets & Consolidating Assets

Management of properties through a trust creates a legal system within which assets can be protected and maintained effectively while safeguarding the interests of the family members. A trust is a tool through which the owner (settlor/donor) transfers property (trust property) to a person (trustee) who retains it for the benefit of another person (beneficiary). A trust should be properly established to ensure ownership of all the group's assets, separation of economic interests from management control, facilitate income and asset distribution, and asset protection against prospective business creditors.

• Preservation of Family Wealth

Trusts can be used to own specific assets that would be inappropriate for a settlor to share between individuals, such as property or a stake in a family-owned business. The usage of a trust allows such individuals to benefit from the assets even though they do not own them. Trusts also help in preserving the capital value of assets for future generations. 

• Avoidance of Probate
• Flexibility & Confidentiality
• Tax Mitigation

At present, the income that is generated from the trust is liable to taxation. Trusts are usually used as an alternative to writing a will as they do not provide any tax efficiency. As a trust is only a vehicle for consolidation of assets, the tax rates that would be applicable in the hands of individual would also apply to the Trust. In a non-discretionary irrevocable Trust, beneficiaries are liable to pay tax according to their tax bracket. In a revocable Trust, the settlor is liable to pay tax according to his tax bracket. In case of a discretionary Trust, it is the Trustees.[i]

• Controlling Distributions

There are no specific provisions under the ITA dealing with dissolution of Trust/taxability on distribution of assets of the Trust. Since, a Trust holds property for the benefit of the beneficiaries, when the properties are distributed/handed over to the beneficiaries, it should not result in any income taxable under the ITA for them. As the Trust does not receive any consideration at the time of distribution, no capital gain implications ought to arise.

In the past, tax authorities have attempted to treat a Trust as an AOP, and apply the provisions of section 45(4)2 of the IT Act[ii] on dissolution of a Trust. However, the Hon’ble Bombay High Court has held that Trustees cannot be taxable as an AOP, and therefore, the provisions of section 45(4) are not applicable.

Hence, the distribution to the beneficiaries at the time of termination of the Trust or otherwise ought not to result in any tax liability.

• Management

Usually, trusts can come out to be very effective for the management of assets of the trust. They are proven to be effective in reducing taxation on capital and income. It may also provide the beneficiaries and the trust assets from punitive taxation.  [iii]

Benefits and Drawbacks of a Trust Structure[iv]

Conclusion:

Various family businesses plan their succession through the use of Private Trusts. The challenges businesses comes under; the uncertainty surrounding reintroduction of inheritance tax[v], and other challenges for setting up a trust make it an exciting subject. Before one steps on to the journey of setting up a family trust, one must ensure a thorough study on the nuances of requisites for setting up a trust.

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