By Indroneel Das
A loophole in the Indian taxation system?that of allowing the creation of family trusts and consequently transferring assets to the trust, has been utilised by some Non-Resident Indians (NRIs) to save huge amounts of tax. Some select, rich NRI families have often been found organising their accumulated wealth and all their assets in a particular legal structure, known as a trust.
A private trust is a legal entity set up to transfer assets of the current owner. The assets are held in the trust for eventual transfer to an intended, pre-specified beneficiary. The primary motivation behind creating a trust is to enable succession planning.
Trust-ing tax payments
There can, however, be an alternate use of the trust structure for questionable tax saving. Today, the number of individuals using trusts to insulate their Indian assets is at an all-time high. Global laws are focussing on information sharing and convergence of taxation regulations, in a bid to stop this practice.
Different types of trusts operate in India. A revocable trust is equivalent to a will, where the assets can be withdrawn from the trust. On the other hand, irrevocable trusts do not allow the withdrawal of assets. Non-discretionary irrevocable trusts allow the owner to decide not only the beneficiaries but also map which assets go to which beneficiary and in what proportion. Discretionary irrevocable trust owners can only name the beneficiaries, without having any say in the eventual asset distribution.
It is this property of a discretionary irrevocable trust, that makes it an ideal instrument for convenient tax savings. Since the named beneficiaries do not know which assets theyll eventually get to own and in what proportion, they can save on income taxes on such income, owing to the lack of certainty.
Finding legal loopholes
In the case of assets such as real estate and shares, the idea of the taxation system is to tax any capital gain that the seller makes when he sells the asset above the acquisition price. However, if an NRI living outside the country transfers the asset to the trust before selling it, the same rules dont apply anymore.
Transferring the assets to the trust is different from selling it to a third party; the transfer of the asset to the trust leads to the creation of a debt between the transferor and the trust. This debt can be done away with by way of gifting. If the transfer of the asset is legally claimed and qualified as a gift, it does not attract any tax. Also, the gifting process can be broken up into many successive transactions at set frequencies.
Facing global regulations
Recently there have been global agreements between governments that prevent foreign settled citizens from sabotaging the tax regime using the trust structure. The US Internal Revenue Service, under the provisions of the US FATCA regulations, need the details of all holdings of a trust in which a US citizen is the beneficiary, even though it may be registered to an Indian settler who is residing in and is a citizen of India.
In India, there is still no taxation against any wealth stemming from an asset that is with the trust, as long as there is no definitive distribution of funds. In Europe too, the advent of the Inheritance taxes have made undue tax saving difficult.
Cracking down with co-operation
Any tax saving mechanism must be modified as soon as there are rumours of a revision in the tax laws. As a result, such trusts are often moved offshore to tax havens, in what legally qualifies as tax evasion and offshore stashing. Increased global co-operation and sharing of information across boundaries has made it difficult to evade taxes.
Indian authorities are now armed with significant amounts of data on the wealth stashed in Switzerland and Panama. Therefore, they are expected to crack down on such insulated family wealth in the coming years. Indian and other global tax authorities will need to focus on taxation of trust assets on a continual basis, even if the trust is moved from its native country.
It means that even greater international co-operation is the need of the hour, along with the implementation of tighter domestic tax laws in every country. Unless the individual domestic tax regulations in every country achieve a reasonable level of cohesion, tax-arbitrage will flourish.
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