Many HNIs create offshore discretionary private trusts with an aim to achieve succession planning goals and escape tax liability in India. However, there is a lack of clarity on taxability of distributions received from these trusts. In this light, there has been an interesting decision given by ITAT Kolkata bench in case of Som Datt v. Assistant Commissioner of Income-tax, Circle-27, Kolkata [2015] 60 taxmann.com 59
Today, I am analyzing this case in greater detail and putting across certain finer learning points to ensure that proper due diligence and documentation is taken care of while setting up and managing these trusts.
Facts of the case
The facts of the case were as follows:
- During the course of assessment proceedings, the Assessing Officer noted that the assessee received a credit of USD 1 MN (in INR terms, a sum of Rs.4.56 crores)
- The assessee claimed that money was received by it from one Trust named White Label Trust, which was constituted under the laws of the Island of Jersey
- First assessee said that trust is managed by ANZ Grindlays Trust Corporation (Jersey) Limited but subsequently took a plea that the trustee had been changed and now HSBC Trust Company (BVI) Limited was appointed as Trustee of the White Label Trust
- Assessee submitted the said money had been sent from the capital account of the Trust and was to be regarded as a capital distribution and not income distribution.
- The Assessing Officer noted that the Trust is a Private Discretionary Trust and in fact a Foreign Trust, not coming under the purview of the Indian Income-tax Act; however, any fund distributed to any resident of India, therefore, undoubtedly, is chargeable to income-tax in the hands of the resident assessee and accordingly he added the sum to the income of the assessee.
Arguments of Income Tax Department (ITD) in the case
- The trust is a Private Discretionary Trust and in fact a Foreign Trust, not coming under the purview of the Indian Income-tax Act;
- However, any fund distributed to any resident of India, therefore, undoubtedly, is chargeable to income-tax in the hands of the resident assessee.
- The question of capital or revenue receipt is irrelevant as it is income in the hands of receiving party and there is no provision in the Indian Income-tax Act to exempt such receipt.
- The only situation where the amount may be left out from chargeability arises when a DTAA exists between two countries which apparently does not exist in this case
- In the absence of financial statements being produced by the Trust, it cannot be ascertained whether the distribution of the amount was from the corpus fund or out of the income of current year.
- The Trust has paid no income tax as per Indian Income-tax Act (ITA). There is also no evidence on record regarding tax payment in the country of its incorporation. The assessee himself has not paid any tax abroad. The amount received by the assessee in Switzerland during the year and brought into India can only be treated as income in terms of Section 5 of ITA.
Arguments of assessee
Assessee relied on the following decisions to support his claim:
- Amitabh Bachchan v. Dy. CIT [2005] 2 SOT 189 (Mum.);
- Smt. Shantaben M. Patel Patel [IT Appeal No. 5000 (Mum.) of 2001, dated 17-2-2006] ;
- CIT v. Provident Investment Co. Ltd.[1957] 32 ITR 190 (SC)
- Uma Polymers (P.) Ltd. v. Dy. CIT [2006] 100 ITD 1 (Jodh) (TM)
- H.H. Maharaja Shri Jyotindrasinhji v. Asstt. CIT [2010] 326 ITR 594/[2008] 174 Taxman 605 (Guj.) (SC)
Decision of ITAT
Two important and inter-related questions of fact raised in the case were:
- Whether the distribution of USD 10 lacs (~ INR 4.5 CR) by the offshore trust is a capital receipt in hands of the assessee and hence not taxable in India?
- In case of offshore trusts, onus rests on whom (assessee or ITD) to prove that funds were genuine and distributions are not taxable in India?
The ITAT considered following points in its decision:
- Assessee has failed to file copy of any Resolution or Minutes or deed of appointment or memorandum which may prove how HSBC Trust Company (BVI) Limited became the new trustee of the Trust and from which date.
- In view of the above, it is not possible to place reliance on the confirmation letter by HSBC that the distribution was from capital contribution – assessee has failed to discharge this onus.
- Assessee failed to file a copy of the Trusts (Jersey) Law, 1984, even though assessee was specifically asked to produce the same
- The assessee expressed his inability to tell whether the accounts for the Trust got audited by the Trustee or not and why the copy of the audited accounts duly approved by the Trustees were not filed
- From the trust deed it was noted that whenever there is change in the trusteeship a memorandum has to be endorsed and has to be permanently annexed to the Settlement Deed stating the names of the trustees for the time being and it has to be signed by the persons named as a trustee so that any person dealing with the Trust may rely upon such memorandum. But in this case, on going through the Trust Deed, no copy of any such memorandum is found . In view of this fact, the assessee has not discharged his onus how HSBC had become the trustee of the said Settlement.
- Onus is on the assessee to prove that HSBC Republic Trust Company (BVI) Limited is the trustee of the Trust Deed as assessee entirely relies on the certificate issued by HSBC Republic Trust Company (BVI) Limited that the amount has been received by the assessee from the discretionary trust as beneficiary out of the accumulated income of the earlier year and therefore the said amount is a capital receipt.
- No accounts relating to the earlier year have been filed so that it could be ascertained whether the assessee has got the income accrued in the earlier years out of which the amount has been distributed by the trustee to the assessee as beneficiary of the discretionary trust.
- The accounts although has not been audited and has not been approved by the trustees except that certified true copy has been signed as a trustee on behalf of HSBC Trust Company (BVI) Limited. In this scenario, these accounts cannot be accepted as evidence that the assessee has received the funds out of the capital funds.
- When assessee makes a claim that the amount received by him is a capital receipt and has been paid out of the capital fund, the onus is on the assessee to prove that the amount has been paid by the Discretionary Trust out of the capital fund.
- In a case where the assessee claims that the money has come out of a source out of India, heavy onus lies on the assessee to adduce evidence and prove that the money has come from outside India not as an Income but as a Capital receipt specially when the Assessing Officer does not have any jurisdiction over the source country. The general principal that the revenue should prove that the assessee has receipt the money as income cannot be applied in such situation as all the evidences and material is in the domain of the Assessing Officer. It is a case where a credit of the amount was found in the books of the assessee, therefore, the assessee is bound to prove the nature and source of the credit.
- Whether the Trust is a genuine Trust and has complied with all the legal requirements of the country in which it has been incorporated cannot be ascertained. The bona fide of the Trustee itself, is not proved. Merely stating that by way of a letter does not prove that the assessee has discharged his onus.
- Once an amount is credited into the books of the assessee, onus is on the assessee to prove the nature and source of the said amount to the satisfaction of the Assessing Officer in view of the clear mandate of the provisions of section 68. The Supreme Court has also taken the same view even prior to the introduction of section 68, in the case of Kale Khan Mohammad Hanif (supra), CIT v. Devi Prasad Vishwanath [1969] 72 ITR 194 (SC) and Roshan Di Hatti v. CIT [1977] 107 ITR 938 (SC).
In view of the above points and the SC decisions, ITAT felt that the assessee has not been able discharge his onus and could not prove that the money has come out of the capital fund of a Discretionary Trust situated out of India. Hence, the claim of the assessee that the said amount is the capital receipt received as a beneficiary of a discretionary trust was rejected.
Information that an AO can ask pertaining to offshore trust at assessment stage
Basis this case, below is an indicative list of documents that an assessee needs to be prepared to provide to Indian tax authorities w.r.t. the offshore trust:
- Details on Founder/Settlor of the Trust,
- No. of years for which the assessee is associated with the Trust,
- Duties and obligations as a beneficiary of the Trust,
- Purpose for which the Trust was set up,
- Source of income of the Trust,
- Identification particulars of the Trust as per 11 Act of the Nation,
- Names of other beneficiaries receiving benefit from the Trust during the year,
- Whether the assessee received gift from the Trust in earlier years,
- Statement of account of Trust Bank statement
- Financial statements of the trust (to ascertain nature of income in hands of assessee)
- Copy of the Trust Law as applicable to the offshore jurisdiction
- Statement/memorandum of trustee re-appointment/change
My thoughts/learning points from this case
- This decision makes it clear that in case of an income earned outside India and remitted to India which not expressly tax exempt under DTAA etc., onus is ALWAYS on the assessee to prove that funds were genuine and distributions were capital receipt, and hence not taxable in India.
- Offshore trust structures are opaque structures and have been heavily misused over the years to park illegal wealth hence assessee need to be doubly precautions to explain his stand on legality and taxability of fund distributions through proper documentation.
- While choosing an offshore jurisdiction, assessee needs to carefully consider points like whether the jurisdiction has a well formed law regarding trusts, will the trustees co-operate in case of investigation by Indian enforcement agencies like ITD, ED, RBI etc.
- It is much better to maintain accounts in such a way that the income and capital bifurcation comes out clearly – also, accounts should be approved + audited else Court may reject the same, as it was done in this case
- This case was pre- 2015 hence judgment speaks about invoking Section 68 however effective 01/07/2015, the Black Money Act has come into picture, which is far more draconian and has exclusive jurisdiction over such issues – so, a case for taking all the more precaution (Read: Black Money Act: An Analysis and Gift by NRI to Resident: Also be aware of Section 68 of ITA)
- Care needs to be taken to disclose the offshore trust in Schedule FA in tax return in India. (Read: How NRI should disclose their foreign income/ assets in Indian tax return)
- Even if proper disclosures are made etc., if the primary purpose of offshore trust is tax avoidance, it can be struck down by the General Anti Avoidance Rules (GAAR) which have been effective 01/04/2017 so need to watch out.
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