The super-rich in India are racking their brains to figure out ways to soften the blow dealt by New Delhi’s decision to impose a stiff surcharge on their income tax.
Many business families that hold their assets under local private trusts — entities that are hit as severely as several FPIs and wealthy salaried individuals — are exploring options such as changing the character of the trust or housing the assets in limited liability partnerships (LLP) which have to pay less tax.
The family trusts — being ‘discretionary’ in nature where the beneficiaries have no say in shares and payouts — are taxed as ‘individual assessees’.
ET spoke to a number of senior tax experts and consultants to get a sense of what the rich are thinking.
“As we look at the impact of surcharge on the superrich, apart from individuals and FPIs (which are trusts), Indian trusts too would be impacted,” said Dinesh Kanabar, CEO of Dhruva Advisors.
Decisions Not Easy “They too would need to assess the impact and consider how to reorganise themselves in the light of the changes. There are trusts who may want to consider distribution of assets, convert themselves from discretionary trusts to specific trusts, etc.,” Kanabar said. Dhruva Advisors is a tax and regulatory boutique.
According to senior chartered accountant Dilip Lakhani, some trusts could consider divesting the investments in listed shares, pay 10% tax on long-term capital gains, and float an LLP to buy back the securities. “The conversion of discretionary trust to determinate (or specific) trusts, though a way to avoid tax, may not help where the income of the trust is large and the income of a beneficiary is more than Rs 2-5 crore,” said Lakhani.
Unlike a discretionary trust whose earnings are taxed, there is no tax at the hands of a specific or determinate trust (where the beneficiaries’ shares on assets are prefixed). However, beneficiaries of a specific trust are taxed and a beneficiary whose income crosses the super-rich threshold has to pay higher tax.
“Wherever possible, the existing discretionary trust (like an individual) may become a partner in a new LLP which can have a provision not to distribute profits for a period of time,” said Lakhani. Thus, instead of distributing earnings and gains to partners, letting earnings from various assets accumulate within an LLP would lower the tax impact (thanks to lower effective tax on LLP).
This possible structuring is aided by a provision in the law that exempts tax when the trust’s assets are moved (or, ‘introduced’, in tax parlance) at ‘cost price’ to an LLP.
But such decisions are not easy. “This seemingly inadvertent change, now confirmed to remain, has put many entrepreneurs and their families in a dilemma which is difficult to resolve. They are grappling with questions whether you can hold family wealth — being strategic shareholders in their own companies — under an LLP structure for example and whether that could have implications under other regulations. Such discussions are expected to hold attention for the next few months,” said Hitesh D Gajaria, partner & head of tax at KPMG India. “If you recall when dividend (above Rs 10 lakh) was taxed a few years ago, discretionary trusts, which are assessed as individuals, were impacted even then," he said.
The surcharge on the income tax on an LLP continues to be at 12%. Compared with this, the surcharge applicable to individuals and trusts with earnings between Rs 2 crore and less than Rs 5 crore was raised from 15% to 25% in the union budget; and, the surcharge was raised from 15% to 37% for those above Rs 5 crore income. Including education cess, the effective rate of income tax on those in the Rs 2-5 crore bracket is now 39% while those above the Rs 5 crore limit is 42.7%. What has put off the rich is the decision to raise the effective tax on the entire income instead of charging higher tax on the extra income above Rs 2 or 5 crore.
Discretionary trusts, which are bankruptcy remote structures, were set up mainly to ringfence family wealth, plan for the next generation, and avoid estate duty as and when the government imposes it. Understandably, families are weighing the pros and cons of plans that alter the arrangement. But promoters planning to migrate from trust to LLP, may even cut deals with ‘friendly’ FPIs which will buy and sell back shares for a fee.