Taxation of Private Trusts

A private trust is not a separate taxable entity in the way a company is, yet its income must be taxed somewhere. Indian income tax law solves this by taxing the trustee as a representative assessee of the beneficiaries, with the rate depending on whether the beneficiaries' shares are known or at the trustee's discretion. Further rules deal with revocable transfers, business income and gifts to trusts. The Income-tax Act, 2025 replaced the Income-tax Act, 1961 from 1 April 2026, carrying forward these principles under new section numbers. This note explains the principles, using the 1961 section numbers by which the case law and literature describe them.

1. The Trustee as Representative Assessee

Because the trustee is the legal owner (Topic 6), income from trust property is received by him. The law treats him as a representative assessee in respect of the income he receives on behalf of, or for the benefit of, the beneficiaries (1961 Act, Section 160). Consequences:

• Same manner and extent: the trustee is assessed in the like manner and to the same extent as the beneficiary would be (1961 Act, Section 161).
• Option to assess the beneficiary directly: the tax authority may instead assess the beneficiary directly on his share (1961 Act, Section 166).
• Right of recovery: a trustee who pays tax for a beneficiary may recover it from him or retain it out of the income.

2. Specific (Determinate) Trusts

Where the beneficiaries and their shares are known and determinate on the face of the instrument, the trustee is taxed on each beneficiary's share as that beneficiary would be: at that beneficiary's slab rates and with his exemptions. The Supreme Court applied this in CWT v Trustees of H.E.H. Nizam's Family (Remainder Wealth) Trust (1977), holding that where shares are determinate, assessment of the trustees must be made separately in respect of each beneficiary's share. In substance, a specific trust is a pass-through.

3. Discretionary Trusts

Where the beneficiaries' shares are indeterminate or unknown, the general rule is that the trust's income is taxed at the maximum marginal rate (1961 Act, Section 164(1)). This prevents income being spread among many low-income beneficiaries to reduce tax. The rule has exceptions, under which the income is taxed as if it were the income of an association of persons, including:

• where none of the beneficiaries has taxable income exceeding the exemption limit, and none is a beneficiary of another trust;
• where the trust was declared by will and is the only trust so declared by the testator, for the benefit of relatives dependent on him;
• certain trusts created before 1 March 1970 for relatives or dependants; and
• trusts for provident funds, superannuation, gratuity and similar employee funds.

Business income

Where a trust's income includes profits and gains of business, the whole income is generally taxed at the maximum marginal rate, even for a specific trust, unless the trust was declared by will exclusively for dependent relatives and is the only such trust (1961 Act, Section 161(1A)).

4. Revocable Transfers and Clubbing

• Revocable transfers: income arising from a revocable transfer of assets, including a transfer to a trust that is revocable, is taxed in the hands of the transferor (1961 Act, Sections 61 and 63). A transfer to a trust is revocable if it contains a provision for re-transfer of income or assets to the transferor, or gives him a right to reassume power over them.
• Irrevocable for the beneficiary's life: a transfer irrevocable during the beneficiary's lifetime is not caught while it remains irrevocable (1961 Act, Section 62).
• Clubbing: income from assets transferred, directly or through a trust, for the benefit of a spouse or son's wife without adequate consideration may be clubbed with the transferor's income (1961 Act, Section 64).

These rules are why the revocability of a family trust, a drafting decision under Section 78 of the Trusts Act (Topic 31), has direct tax consequences.

5. Gifts to and from Trusts

• Receipts by trusts: sums or property received without adequate consideration are generally taxable as income, but receipts by a trust created or established solely for the benefit of relatives of the individual transferor are excluded (1961 Act, Section 56(2)(x)).
• Distributions: distributions by a trust to its beneficiaries out of income already taxed in the trustee's hands are generally not taxed again.
• Settlement of capital assets: a transfer of a capital asset by way of gift or irrevocable trust is generally not a "transfer" giving rise to capital gains (1961 Act, Section 47(iii)).

6. The Income-tax Act, 2025

The Income-tax Act, 2025 came into force on 1 April 2026 and replaced the 1961 Act. It introduces the concept of a tax year in place of the previous year and assessment year, and renumbers and rewrites the provisions in simpler language. The principles above (representative assessment, determinate and indeterminate shares, the maximum marginal rate for discretionary trusts, revocable transfers and clubbing) continue under the new Act. For income of tax years from 2026-27, the corresponding sections of the 2025 Act must be cited; for earlier years, the 1961 Act continues to apply.

7. Related Topics and Provisions

• Classification of trusts (Topic 5): specific and discretionary trusts
• Nature of the beneficiary's interest (Topic 6)
• Extinction and revocation (Topic 31): revocability
• Family trusts and estate planning (Topic 54)