The Special Bench of the Income Tax Appellate Tribunal (ITAT), Mumbai on April 9, 2025,  addressed a significant issue impacting private discretionary trusts. The question before the Special Bench was:

“Whether, in the case of private discretionary trusts whose income is chargeable to tax at the maximum marginal rate, surcharge is chargeable at the highest applicable rate or at slab rates?”

The issue arose in the appeal filed by Araadhya Jain Trust, where the Centralized Processing Centre had levied the highest surcharge rate despite the trust’s total income being only ₹4.85 lakhs. This led to conflicting interpretations on chargeability of surcharge for a Discretionary trust which is subjected to tax at the maximum marginal rate (MMR) under section 164 read with section 2(29C) of the Act.

Key Highlights of the Special Bench Order:

1. While the definition of ‘maximum marginal rate’ under section 2(29)(c) refers to surcharge, MMR must be determined basis the rates as provided in the First Schedule of the Finance Act of the relevant year and the said rate is applicable in relation to highest slab of income for an individual, AOP etc.
2. The definition of MMR includes surcharge “if any,” but this does not imply automatic application of the highest surcharge rate (i.e., 37%) irrespective of the assessee’s income.
3. Surcharge applicability must be determined in accordance with slab-based thresholds prescribed in Paragraph A, Part I of the First Schedule to the relevant Finance Act and not fixed at the maximum rate.
4. The Special Bench emphasized that surcharge is distinct from the income-tax rate and its applicability is governed solely by the quantum of total income and must be computed on the income tax having reference to slab rates as prescribed in the First Schedule
5. The Revenue’s argument that the highest surcharge must apply as a deterrence against discretionary trusts was rejected. The Tribunal clarified that surcharge should be levied only when the trust’s total income exceeds prescribed thresholds (e.g., ₹50 lakhs for 10% surcharge, ₹1 crore for 15%, and so on). It was also observed by the Tribunal that should the Revenue contention of leaving surcharge at the highest rate be accepted, it will make the exception provided in the first proviso under the heading ‘surcharge on income tax’ otiose.
6. The ruling overrules contrary earlier decisions, notably Araadhya Jain Trust for AY 2022-23 and Kapur Family Trust, relying instead on more recent and factually relevant decisions which interpreted surcharge application in line with slab thresholds.

KNAV Comments:

This decision by the Special Bench provides welcome clarity and relief to private discretionary trusts by affirming that surcharge must be levied based on income thresholds and not automatically at the highest rate, even when income tax is levied at MMR. The ruling brings consistency in interpretation and helps prevent excessive taxation on low-income trusts.

Taxpayers, particularly family and employee benefit trusts, should assess past and pending assessments to ensure surcharge has not been levied contrary to this principle. The decision will likely influence ongoing litigation and administrative proceedings where this issue is contested.

Surcharge on Private Discretionary Trusts – Special Bench Ruling – Read Here
https://itat.gov.in/public/files/upload/1728384347-2197%20Aradhya%20Jain%20Trust.pdf