Discretionary and Specific Trusts
Introduction
A discretionary trust gives trustees absolute discretion over distributing income or capital among beneficiaries. A specific trust has pre-determined beneficiaries with fixed shares in income and corpus. While both are taxed in a representative capacity, discretionary trusts are taxed under Section 164, and specific trusts under Section 161.
Types of Trusts
- Oral and Written Trusts– A trust can be created orally or through a written document.
- Discretionary Trust– Trustees decide the distribution of income/capital.
- Specific Trust– Beneficiaries have a definite right to income or corpus.
Key Differences Between Discretionary and Specific Trusts
- If beneficiaries’ shares are fixed and known, it is a specific trust (Section 161).
- If shares are not fixed, it is a discretionary trust (Section 164).
- Even a single-beneficiary discretionary trust is taxed underSection 164if income is not specifically receivable for that beneficiary.
Taxation of Trusts
Specific Trust (Section 161)
- If the beneficiary’s share is determinate, income is taxed in the hands of the trustee as a representative-assessee or directly in the hands of the beneficiaries.
- Tax is levied at the rate applicable to the beneficiary.
- The Assessing Officer can choose to tax either the trustee or the beneficiary, but not both.
Discretionary Trust (Section 164)
- If beneficiaries’ shares are indeterminate, the trustee is taxed as a representative-assessee at the maximum marginal rate.
- If income is received by a provident fund, pension fund, or gratuity fund, it is exempt underSection 10(25).
Tax Rates for Trusts
Maximum Marginal Tax Rate (Section 164(1))
- Applies when:
o Beneficiaries’ shares are not fixed.
o The trust has business income.
o The trust is not created by will or for dependent relatives.
Tax Rate Applicable to Beneficiary (Section 161(1))
- Applies when:
o Beneficiary’s share is determinate and known.
o Trust does not have business income.
Tax Rate as per AOP (First Proviso to Section 164(1))
- Applies when:
o When none of the beneficiaries has taxable income above the exemption limit or is a beneficiary of another trust.
o Where the trust is declared by a person by ‘will’ and such trust is the only trust declared by him.
o Where a pre-1970 non-testamentary trust is created exclusively for dependents/relatives.
o Where business income arises from a trust declared by any person by ‘will’ exclusively for a dependent relative.
o Where trustees hold income for employee welfare funds
Apportionment of Income Between Specific and Discretionary Trusts
- If a trust has both determinate and indeterminate beneficiaries, taxation is split:
o Determinate portion is taxed under Section 161(1).
o Indeterminate portion is taxed under Section 164(1).
Taxation of Partially Taxable Trusts (Section 165)
- If only part of a trust’s income is taxable, tax is proportionally calculated.
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