Taxation of Private Discretionary Trust Remanded; Applicability of MMR depends on verification of Will

ORDER

Siddhartha Nautiyal, Judicial Member.- This appeal has been filed by the Assessee against the order passed by the Ld. Commissioner of Income Tax (Appeals), (in short “Ld. CIT(A)”), ADDL/JCIT (A)-2, Coimbatore vide order dated 14.03.2025 passed for A.Y. 2024-25.

2. The assessee has raised the following grounds of appeal:

“1. In law and in facts and circumstances of the Appellant’s case, the learned Commissioner ofIncome Tax (Appeals) has grossly erred in points of law and facts.

2. In law and in facts and circumstances of the Appellant’s case, the learned Commissioner of Income Tax (Appeals) has erred in holding status of assessee as AOP/BOI. The correct status is that of Individual.

3. In law and in facts and circumstances of the Appellant’s case, the learned Commissioner of Income Tax (Appeals) has grossly erred in holding to charge income tax at maximum marginal rate @ 30%.

4. In law and in facts and circumstances of the Appellant’s case, the learned Commissioner of Income Tax (Appeals) has grossly erred in holding to charge interest u/s 234B ofI.T. Act of Rs. 4,356.

5. In law and in facts and circumstances of the Appellant’s case, the learned Commissioner of Income Tax (Appeals) has grossly erred in holding to charge interest u/s 234C of I. TAct of Rs. 3,667.

6. In law and in facts and circumstances of the Appellant’s case, the learned Commissioner of Income Tax (Appeals) has grossly erred in holding to charge additional tax of Rs. 1,150.

7. In law and in facts and circumstances of the Appellant’s case, the learned Commissioner of Income Tax (Appeals) has grossly erred in raising demand of Rs. 58,882.

8. Your appellant reserves the right to add, alter, amend all or any of the above grounds of appeal as may be advised from time to time. “

3. The brief facts of the case are that the assessee, Niruben Ashokbhai Mehta Family Trust, filed its return of income on 31.07.2024 declaring total income of Rs. 2,94,000/- and claiming a refund of Rs. 39,712/-. The return was filed under the status of AOP/BOI with sub-status of Business Trust. The return was processed by CPC, Bengaluru, and an intimation under section 143(1) of the Act was issued computing the income at Rs. 2,93,940/-. While processing the return, CPC treated the assessee as an AOP/BOI and computed tax at the maximum marginal rate of 30% and surcharge at 25%, and also levied interest under sections 234B and 234C and additional tax of Rs. 1,150/-, resulting in a total demand of Rs. 81,810/-. Aggrieved, the assessee filed an appeal before the CIT(A).

4. In appeal, the assessee challenged the assessment under section 143(1) of the Act. The submitted that the Assessing Officer erred in treating the assessee as an AOP/BOI instead of an “Individual”. The assessee submitted that the trust was settled under a Will and became effective on the death of the testator, Smt. Niruben Ashokbhai Mehta, and therefore the correct status was that of an individual. In support of this contention, the assessee relied heavily on the judgment of the Hon’ble Gujarat High Court in Deepak Family Trust v. CIT [1995] 211 ITR 575 (Gujarat), wherein it was held that trustees of a discretionary trust should be assessed in the status of “individual” and not as an AOP, and therefore entitled to benefits available to individuals. The assessee also relied on Harsiddh Specific Family Trust v. CIT [2002] 258 ITR 785 (Gujarat), where the Court held that trustees of discretionary trusts must be treated as individuals for tax purposes. On this basis, the assessee contended that the CPC erred in applying the maximum marginal rate and that tax should instead have been computed at normal individual slab rates. The assessee further submitted that surcharge was wrongly levied at 25% even though the income was below Rs. 50 lakhs, and that interest under sections 234B and 234C and additional tax should not have been levied. The assessee further argued that the issues were debatable and therefore could not be adjusted in processing under section 143(1) of the Act.

5. The CIT(A) examined the return and noted that the assessee had itself selected the status of AOP/BOI in the return and had declared “No” in the ITR fields relating to section 160(1)(iv) conditions viz. that the beneficiaries’ shares were determinate or known, that all beneficiaries had income below the basic exemption limit, and that the trust was the only trust declared under a Will. Based on these declarations, the CIT(A) held that the trust fell within the provisions of section 164(1) and 164(3), which mandate taxation at the maximum marginal rate when shares of beneficiaries are “indeterminate” or “unknown”. The CIT(A) also relied on the decision of the Hon’ble Kerala High Court in CIT v. C.V. Divakaran Family Trust (Kerala)/[2002] 254 ITR 222 (Kerala), wherein it was held that where beneficiaries’ shares are indeterminate, the trust must be assessed at the maximum marginal rate, and that the statutory definition leaves no scope for alternative interpretation. The Kerala High Court further relied on Surendranath Gangopadhyaya Trust v. CIT ITR 149(Cal.) and Piarelal Sakseria Family Trust v. CIT [1982] 136 ITR 583 (Madhya Pradesh), which also held that discretionary trusts with indeterminate beneficiary shares must be taxed at maximum marginal rates. Applying these judicial principles, the CIT(A) rejected the assessee’s claim of individual status and upheld the maximum marginal rate of taxation. With respect to surcharge, the CIT(A) accepted the assessee’s argument that surcharge is not leviable where total income does not exceed Rs. 50 lakhs. Since the income was only Rs. 2,94,000/, the CIT(A) held that levy of surcharge was incorrect and directed the Assessing Officer to delete surcharge of Rs. 22,046/-. Regarding interest under sections 234B and 234C and additional tax, the CIT(A) held that the levy of interest is consequential and system-generated, and directed the Assessing Officer to recalculate interest after giving effect to the surcharge deletion.

6. The assessee is in appeal before us against the order passed by CIT(Appeals) dismissing the appeal of the assessee. We have heard the rival contentions and perused the material on record.

7. On merits, before us the assessee a private family trust, has challenged the computation of tax at the maximum marginal rate under section 164 of the Act. The learned CIT(A) has held that since the assessee had itself filed the return declaring the status as AOP/BOI and had declared in the return that the shares of the beneficiaries were indeterminate, the CPC was justified in applying the provisions of section 164 and computing tax at the maximum marginal rate. We find that the conclusion of the learned CIT(A) to the extent that the CPC action was based on the return as filed by the assessee cannot be faulted with, as the assessee itself selected the status of AOP/BOI in the return and answered “No” in the relevant fields of the ITR relating to determination of beneficiary shares and applicability of section 160(1)(iv) of the Act. Therefore, the findings of the learned CIT(A) on this aspect remain undisturbed.

8. However, the assessee has raised a substantive contention based on judicial precedents of the Hon’ble Gujarat High Court that the trust is a trust created under a Will and therefore, subject to fulfilment of certain conditions, the income of the trust may be taxable at the rates applicable to an individual and not at the maximum marginal rate. In order to adjudicate this claim, it becomes necessary to examine the statutory framework.

9. Section 160(1)(iv) of the Income-tax Act reads as under:

“160. (1) For the purposes of this Act, ‘representative assessee’ means—

(iv) in respect of income which a trustee appointed under a trust declared by a duly executed instrument in writing whether testamentary or otherwise receives or is entitled to receive on behalf or for the benefit of any person, such trustee or trustees.”

10. Section 164(1) reads as under:

“164. (1) Subject to the provisions of sub-sections (2) and (3), where any income in respect of which the persons mentioned in clauses (iii) and (iv) of sub-section (1) of section 160 are liable as representative assessees or any part thereof is not specifically receivable on behalf or for the benefit of any one person or where the individual shares of the persons on whose behalf or for whose benefit such income or such part thereof is receivable are indeterminate or unknown, tax shall be charged on the relevant income or part of relevant income at the maximum marginal rate.”

11. Section 164(3) provides exceptions and reads:

“164(3) In a case where the relevant income is receivable under a trust declared by any person by will and such trust is the only trust so declared by him; or where none of the beneficiaries has any other income chargeable under this Act exceeding the maximum amount not chargeable to tax in the case of an association of persons; or where the relevant income is receivable under a trust created before the 1st day of March, 1970. tax shall be charged on the relevant income as if the relevant income were the total income of an association of persons.”

12. The Hon’ble Gujarat High Court in Deepak Family Trust (supra) and Harsiddh Specific Family Trust v. CIT [2002] 258 ITR 785 (Gujarat) has held that where a trust is created under a Will, the trust is the only trust so declared by the testator, the beneficiaries are dependent relatives and the trustee is assessable as a representative assessee under section 160(1)(iv), the trust is to be assessed in the status of an “individual” and taxed at normal rates applicable to individuals and not at the maximum marginal rate. The Hon’ble Gujarat High Court has therefore laid down the following substantive conditions for applying individual tax rates: the trust must be created under a Will; it must be the only trust so created by the testator; the beneficiaries must be identifiable dependent relatives; and the trust must fall within the representative assessee framework of section 160(1)(iv) of the Act.

13. In CIT v. Kantilal Harilal Family Trust (Gujarat), the Hon’ble Gujarat High Court examined the taxability of income of a discretionary trust where the shares of beneficiaries were indeterminate, and held that in terms of Explanation 2 to section 164 of the Income Tax Act, 1961, the income of such a trust is mandatorily assessable at the maximum marginal rate, meaning the rate applicable to the highest slab of income provided for an association of persons under the relevant Finance Act. The Court noted that the assessee trust was running a hotel business and that during survey it was found that the business income was effectively that of the trust, and the Assessing Officer accordingly assessed the trust’s income at the maximum marginal rate. The Tribunal, however, directed assessment at lower rates, relying on certain factual findings and earlier appellate orders. The High Court held that the Tribunal erred in doing so, observing that the language of section 164 and Explanation 2 thereto leaves no room for interpretation where the beneficiaries’ shares are unknown or discretionary, and that the statute itself provides that the highest applicable slab rate should be applied uniformly. Relying extensively on the judgment of the Kerala High Court in C.V. Divakaran Family Trust (supra), which held that “maximum marginal rate” means the rate applicable to the highest slab of income for an AOP, and further supported by the decisions of the Calcutta High Court in Surendranath Gangopadhyaya Trust (supra) and the Madhya Pradesh High Court in Piarelal Sakseria Family Trust (supra) the Gujarat High Court confirmed that discretionary trusts with indeterminate shares cannot be assessed at concessional or individual rates. It held that the Tribunal had committed an error in directing assessment otherwise than at the maximum marginal rate, and therefore set aside the orders below, directing the Assessing Officer to reassess the matter afresh strictly in light of the statutory provisions and the judicial interpretation mandating application of the maximum marginal rate. In the case of the Hon’ble Kerala High Court in C.V. Divakaran Family Trust (supra) the Court undertook a detailed examination of the scheme of section 164 of the Income-tax Act and held that the provision operates as an independent charging section in respect of discretionary trusts. The Court observed that where the beneficiaries’ shares are indeterminate or unknown, the statute mandates taxation of the trust income at the “maximum marginal rate” without any discretion in the hands of the Assessing Officer. The Court held that Explanation 2 to section 164 clearly defines the expression “maximum marginal rate” as the rate of tax applicable to the highest slab of income in the case of an association of persons under the relevant Finance Act. The Kerala High Court rejected the argument that the term “marginal” implied some form of averaging or moderation in taxation and held that once the conditions in section 164(1) are satisfied, the maximum marginal rate applies automatically. The Court further noted that the structure of section 164 is intended to prevent avoidance of tax through discretionary trusts by taxing the trustee at the highest possible rate when the shares of the beneficiaries cannot be ascertained. Relying on earlier decisions of the Calcutta and Madhya Pradesh High Courts, the Kerala High Court held that the Assessing Officer was correct in applying the maximum marginal rate and that no alternative interpretation was permissible when the statutory language was clear. In the case of Surendranath Gangopadhyaya Trust (supra), the Hon’ble Calcutta High Court examined a case where the trust deed conferred discretion on the trustees in the allocation of income among beneficiaries and did not specify individual shares. The Court held that in such a situation, the beneficiaries’ shares were indeterminate and therefore the provisions of section 164(1) squarely applied. The Court observed that the intention of the legislature was to ensure that where the enjoyment of income is uncertain or dependent on the discretion of the trustees, the trust should not secure a tax advantage by claiming individual slab rates applicable to beneficiaries. The Court held that the trustee, being a representative assessee under section 160(1)(iv), was liable to be assessed in accordance with section 164 and that the income must be taxed at the maximum marginal rate. The Court further held that unless the trust fell within the specific exceptions provided in the proviso to section 164, the maximum marginal rate was mandatory and could not be avoided merely by arguing that the trustees acted for the benefit of individuals. The Hon’ble Madhya Pradesh High Court in Piarelal Sakseria Family Trust (supra) also dealt with the issue of taxation of discretionary trusts where the beneficiaries’ shares were not specified. The Court held that the statutory provisions contained in section 164 were designed to address situations where the allocation of income was uncertain and therefore capable of being manipulated to reduce tax liability. The Court noted that when the trust deed did not specify the proportionate entitlement of beneficiaries and the trustees retained discretion to distribute income, the beneficiaries’ shares were necessarily indeterminate. In such cases, the trustee, as a representative assessee under section 160(1)(iv), was liable to be taxed at the maximum marginal rate. The Court also rejected the contention that the trust should be treated as an individual for tax purposes, holding that such treatment was only available where the trust satisfied the conditions contemplated in the proviso to section 164. Since the trust before it did not fall within any statutory exception, the Court held that the maximum marginal rate applied. These decisions in our considered view collectively establish the legal principle that in the case of discretionary trusts where the beneficiaries’ shares are indeterminate or unknown, the provisions of section 164(1) mandate taxation at the maximum marginal rate, and such taxation is automatic unless the trust falls within the narrow statutory exceptions provided in section 164(3) or the proviso to section 164 of the Act.

14. In the present case, the application of section 164(1) and 164(3) requires factual verification as to whether the assessee satisfies the statutory exceptions and judicially recognized conditions laid down by the Hon’ble Gujarat High Court. Since no such examination has been undertaken, and the necessary documents including the complete Will and trust deed require verification, we deem it appropriate to restore the matter to the file of the Assessing Officer.

15. Accordingly, while confirming the finding of the learned CIT(A) that the CPC was justified in applying maximum marginal rate based on the return as filed and that the order of the learned CIT(A) cannot be faulted on this ground, however, in the interests of justice, we set aside the issue of taxability under section 164 of the Act to the file of the Assessing Officer with a direction to carry out necessary verification as to whether the trust was created under a Will, whether it is the only trust declared by the testator, whether the beneficiaries are dependent relatives and identifiable, whether the trust satisfies the representative assessee conditions of section 160(1)(iv), and whether the shares of the beneficiaries are in fact determinate upon examination of the trust instrument, and thereafter to determine whether the assessee is entitled to be taxed in the status of an individual in accordance with the Gujarat High Court decisions or whether the maximum marginal rate under section 164(1) applies.

16. In the result, the matter is restored to the file of the Assessing Officer for fresh adjudication and the appeal is allowed for statistical purposes.