This article has been written by Ayush Sahay pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho.

Introduction

For any ordinary person, the principle of letting somebody else be in possession of something that is yours is called trust. But there are other ways through which a settler gives the other party their assets to hold or to be utilized for the benefit of a third party. Now letting another party hold your assets is not always the best option but how does the trust system work and why do people establish trusts? We will read all about this along with what are the important factors to keep in mind while drafting a trust deed. 

What is trust? 

As per interpretation of Section 3 of the Indian Trusts Act, “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 above interpretation can be condensed into this. Party A called the trustee gives Party B rights to possess their property, which shall be used for the benefit of Party C, called the beneficiary. This forms a trust and these trusts shall then determine how the trustee’s asset will be utilized and managed. 

How are they formed?

It is important to realize that a trust is set up to decide the manner in which the money or the assets in the picture of the settlor will be utilized in the due course of their life or even after their death. 

A settler along with their lawyer lays out a detailed will that defines the manner in which their assets will be transferred to the trustee. The trust functions in the manner that has been determined in the will that the settlor and their lawyer finalize upon. To understand what legislation concerns a trust it is important for us to understand the types of trusts. In a larger frame, they can be divided as (i) Private Trusts and (ii) Public Trusts

Legislations concerning a trust

The Private Trusts in India are governed by the Indian Trusts Act, 1882, and have different kinds of trusts within its umbrella.

  • Revocable trust:

These trusts are established during the settlor’s lifetime and the can as per the settlor’s discretion be altered or revoked completely, sometimes known as living trusts, are ones in which the settlor transfers the title to a property to the trust, serves as the original trustee, and has the power to withdraw the property from the trust during his or her lifetime. Probate avoidance is made much easier with revocable trusts. The assets will not be subject to probate if they are transferred to a revocable trust during the settlor’s lifetime and are owned by the trust at the time of the settlor’s death.

  • Irrevocable trust:

An irrevocable trust is one that cannot be amended, modified, or canceled after it has been established. No one, including the settlor, may take a property out of an irrevocable trust once it has been transferred. Survivorship life insurance can be purchased, and the proceeds can be maintained in this kind of trust. In big estates, this sort of survivorship life insurance can help with estate tax planning; nevertheless, survivorship life insurance kept in an irrevocable trust might have major ramifications.

  • Constructive trust:

This trust is a trust that is implied. A court determines whether or not there is an implied trust based on particular facts and circumstances. In the absence of a formal declaration of trust, the court may decide that the property owner intended for the property to be utilized for a specific purpose or to belong to a specific individual. While someone may assume legal title over a piece of property, equitable considerations may dictate that the equitable title to that property actually belongs to someone else.

  • Spendthrift trust:

A spendthrift trust is one that is established for a beneficiary and does not allow the beneficiary to sell or pledge the trust’s interests. It is safeguarded from the creditors of the beneficiaries until the trust property is dispersed out of the trust and transferred to the beneficiaries. While Public Trusts are classified either as religious or charitable trusts that are governed by them;

  1. The Charitable and Religious Trusts Act, 1920,
  2. The Religious Endowments Act, 1863,
  3. The Charitable Endowments Act, 1890,
  4. The Societies Registration Act, 1860.

Along with these legislations they are governed by state legislation like the Bombay Public Trust Act, 1950, etc. 

Advantages and disadvantages of setting up a trust 

Like everything out there, even trust has advantages and disadvantages which we will discuss here.

A. Advantages:

  1. Tax Benefits on a long-term basis for the trust.
  2. Reducing the chances of challenges against someone’s trust as per their Will or trust.

B. Disadvantages

  1. The problem of not being able to reverse the process of setting up a trust. 
  2. High chances of losing control over the assets that have been used to set up the trust.

Often at times, the advantages of something are misused and the same happens in the case of trusts, which can be seen in Escorts Benefit & Welfare Trust (EBWT) v. ITO ITA, where a Private Trust, where in the year 2016-17  they received a dividend income of 4.47.60,037 Rupees. They claimed for an exemption of the mentioned amount under section 10 (34) of the Income Tax Act as they stated that the dividend distribution tax had already been paid by Escorts Limited, which is both the sole beneficiary and the settlor of EBWT. After this, the Assessing Officer passed an order stating that EBWT is an invalid trust under the provisions of the Indian Trusts Act, 1882 where it states that a trust ceases to be invalid in cases the settlor and the beneficiary are the same entities. 

The Income Tax Appellate Tribunal Bench at Delhi in the case EBWT, they have reaffirmed the concepts such as I trust validity; (ii) the use of trusts to hold treasury shares; and (iii) the taxation of its income as a representation of the benefactors under the requirements of Sections 160-166 of the Income-Tax Act, 1961 (IT Act).

Documents required for the registration of trust and process of trust registration

  1. Trust Deed;
  2. ID Proof (Voter ID, Driving License, Aadhar Card, etc.);
  3. Passport size photos of all parties mentioned in the Trust Deed;
  4. Aadhar Card and PAN Card copies of all parties mentioned in the Trust Deed;
  5. Registered Office Address Proof (electricity bill, etc.).

What is a trust deed?

A trust when has been entered into or has been created, be it private or public, is an obligatory relationship between the trustee, the settlor, and the beneficiaries. Thus to ensure that the obligations and rights are not affected in any ill manner, a trust deed is entered into (which works in the same manner as any agreement), while codifying the relationship between the parties involved.

Important clauses in a trust deed

Along with the basic boilerplate clauses, a few important a few clauses that a settlor and a trustee should ensure are watertight are as given below:

  1. Cessation/ Termination of Trusteeship: This clause will determine the circumstances where the trusteeship between the selected trustees and the trust will come to an end. This comes in handy in case there are members of the trust trying to take advantage of the trust to evade taxes or to launder the same.
  2. Power of the Trustees: Through this clause, the trustees are prohibited from acting in any way that goes beyond the trust deed’s stated powers. For the general operation and administration of the trust, the trustees are often assigned the following powers:
    1. Recruitment and appointment.
    2. Filing lawsuits on behalf of the trust.
    3. Accepting donations and gifts. 
    4. Investing in the trust.
    5. Opening bank and other accounts for the operational and financial functioning of the trust, etc.

3. Accounts and Audit: For a trust to function smoothly without any hindrance from the governmental agencies it is important for it to maintain the correct books of accounts and get them audited as and when required. 

4. Amendments to the Rules and Regulations: This clause will mention who can and how can they make amendments to the rules and regulations of the trust.

5. Winding up: In the event that the company is wound up, the assets of the trust are not transferred to the trustees. With the consent of the charity commissioner/Court/any other law as may be relevant at the moment, they shall be transferred to another comparable trust or organization whose goals are identical to those of this trust.

Conclusion

It is a known fact that trusts are often associated with individuals who have a high net worth and are looking forward to passing down these assets to their heirs or putting them to some charitable use. If you want to set up a trust, you’ll undoubtedly have to give up some control of your assets’ distribution. A will is the simplest way to transmit property to a loved one without using trust. You may be subject to more taxes if you take this path, and your estate will have to go through the process of making claims. So, to ensure that you know how the future of your assets will be like you are more likely to set up a trust. Keeping in mind the aforementioned facts as to why a trust is beneficial and having the clarity of what clauses in a trust deed are important to be clarified and should be free from any loopholes, setting up a trust becomes easy. 

References

  1. https://www.investopedia.com/terms/t/trust.asp.
  2. https://cleartax.in/s/indian-trusts-act.
  3. https://cleartax.in/s/trust-deed-format-download.
  4. https://indiankanoon.org/doc/109686206/.
  5. https://tax.cyrilamarchandblogs.com/2020/07/trust-is-trustworthy-not-a-device-to-evade-tax-itat-delhi/#_ftn1.

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