Jigar M. Patel
International Tax Attorney
Strategic Drafting of Your Will can help Your Family achieve Smart Tax Planning Benefits
When you execute your Will, it is understandable that you as a Testator may wish to distribute your properties amongst close members of your family. While doing so, you should keep in mind the taxable income and wealth of the beneficiaries under your Will. If their taxable income attracts the highest tax bracket, direct distribution of assets to them would add up to their future tax burden.
Planning Tax-friendly Distribution of Properties
In such a case, if the Testator plans to distribute such properties under the Will to family members, children or HUFs, whose taxable income attracts tax at lower average rates, this would prove to be beneficial from the point of view of tax planning.
What can be done, in case all members of the family are in the top tax bracket of 30%? In such a circumstance, useful tax saving can be availed via creation of a discretionary trust under Will. Under the provisions of Section 164 of the Income-tax Act, one private discretionary trust created under a Will, attracts tax at normal rates applicable in the case of an individual and such an entity would be taxed as a separate and distinct assessable unit in the status of an AOP.
Creation of a Discretionary Trust under a Will
A trust in which either the beneficiaries are not determined, or if determined, their share in the income or assets of the trust is not determined, is known as a ‘Discretionary Trust.’ In case of such a trust, the trustees are given full rights to distribute the income and assets amongst the beneficiaries at their discretion.
It needs to be noted that while settling such a Trust, even beneficiaries that may come in existence in future such as son’s wife, HUF, grandchildren etc. can also be included as beneficiaries and distribution of assets to them in future can also help overcome the clubbing of income provisions.
While executing his Will, a person can plan to form one such discretionary trust under the Will and make relevant provisions in regard to the same. The existence of such a trust comes into effect after his death and the assets allotted to the trust constitute the trust fund.
Since the trustees of such trust have wide powers to distribute income and assets to the beneficiaries, it is desirable that proper persons are appointed as trustees. Moreover, to avail of the benefit of tax at normal rates, such trust should be the only trust created under the Will of the testator.
Tax Saving through a Discretionary Trust
Mr. Shah creates a discretionary trust under his Will with his family members as beneficiaries under the Trust. He leaves behind assets of Rs. 2 crores which generate annual income of Rs. 15 lakhs. All the family members being taxpayers in the top bracket of 31.20%, if Shah’s assets had been received individually by any of them, the income-tax payable on the income of Rs. 15 lakhs would have been Rs. 4,68,000.
The discretionary trust under Shah’s Will being considered as a separate entity for tax purpose, the appropriate tax on the taxable income of Rs. 15 lakhs would work out to only Rs. 1,56,000. Thus, the effective tax saving for the Shah family would be Rs. 3,12,000 (Rs. 4,68,000 – Rs. 1,56,000).
