1. Facts of the Case

The recent decision of the Bangalore Bench of the Income Tax Appellate Tribunal (‘ITAT’) in the case of Buckeye Trust^[1] delves into the intricate application of tax laws concerning the receipt of assets by a private discretionary trust

Buckeye Trust (the “Taxpayer”) was constituted under the Indian Trust Act, 1882, as a private discretionary trust. The trust received assets valued at INR 669.27 crores from the settlor. The settled assets included interest in partnership firms where the settlor was a partner and shares of an unlisted private limited company. Considering that beneficiaries of the trust were ‘relatives’ of the settlor, the trust filed a Nil return of income. The said return was accepted by the Income Tax Officer in assessment proceedings concluded under section 143(3) of the Act.

The learned Commissioner of Income Tax (‘CIT(A)’), upon perusal of assessments records and post reflecting on submissions made by the taxpayer to a notice issued under section 263 of the Act, inferred that trust was not created solely for the benefit of relatives of the settlor. The CIT(A) noted that the trust deed provided trustees with the flexibility to add any class of persons (whether in existence or ascertained) or a charity as beneficiaries to the trust. In view thereof, the CIT(A) concluded that trust was not ‘solely’ for the benefit of relatives of the settlor, and hence, exemption from taxability as provided in the fourth Proviso to Section 56(2)(x) was not available and the entire amount of INR 669.27 was brought to tax as ‘income from other sources’ under section 56(2)(x) of the Act.

Aggrieved by the order of the CIT(A), the taxpayer filed an appeal before the ITAT.

[1] Buckeye Trust v. PCIT (ITA No. 1051/Bang/2024)

2. Issues in Consideration

The key issues raised by the taxpayer in the appeal were as follows:

• Taxability of transfer under section 56(2)(x): The taxpayer contended that the trust was created solely for the benefit of the settlors ‘relatives’ and hence, any transfer of property is not subjectable to tax within the provisions of this section. Even if the section applies, as per the definition of ‘property’ stated in section 56(2)(x), it does not cover ‘interest in partnership firms’
• Receipt of funds in a fiduciary capacity: The taxpayer contended that the receipt of assets was not gratuitous or without consideration. The trust received the assets in a fiduciary capacity as custodians for the beneficiaries, and the trust, via the trustees, had no right to enjoy the receipt as owner.
• Genuine Transactions: Taxpayer contended that the transactions were genuine and not colourable in nature. Application of section 56(2)(x) in such a case would be unjustified and contrary to the intent of the law.
• Validity of jurisdiction under section 263: The counsel of the taxpayer desired to argue the case on merits, and hence, this ground was not adjudicated and dismissed as not pressed.

3. Revenue’s Contentions

• Right to add beneficiaries: Assertion made by the taxpayer that trust was created solely for the benefit of relatives is incorrect as the trust deed categorical allowed for inclusion of outsiders, including charity, thereby violating the ‘relative’ condition required for exemption under Section 56(2)(x).
• Valuation of assets transferred: The income tax officer failed to scrutinize the valuation of the transferred partnership interest and unlisted shares.

4. Findings of the ITAT and Conclusion

• • Taxability under section 56(2)(x):

 Basis the language in the trust deed, which permitted the trustee to add any person or class of person or charity as the beneficiary of the trust, the ITAT affirmed the view of the CIT(A) that the trust was not restricted to ‘relatives’ of the settlor.

 The ITAT also dwelled into the connotation and scope of the term ‘shares and securities’ as stated within the definition of ‘property’ in section 56(2)(x) to ascertain if ‘interest in partnership firm’ falls in the category of ‘shares’ as used in explanation (d) of section 56(2)(vii). With the aid of detailed analysis and judicial precedent on the meaning of the term ‘interest in a partnership firm, ITAT equated interest in a partnership firm with a share in a partnership firm and held that the term shares as used in the explanation to section 56(2)(x) should not be restricted only to shares of a company, rather it is wide enough to mean a part or portion of something.  Basis thereon, ITAT concluded that ‘interest in a partnership firm’ falls in the category of shares and the same is covered by the provisions of explanation (d) of section 56(2)(vii).

• • Receipt without consideration in a fiduciary capacity:

The ITAT noted that immediately post execution of the trust deed, the partnership firms were reconstituted with the settlor retired from these firms, and by virtue of the trust deed, the family members and other persons (future beneficiaries which can be included as beneficiaries of the trust) were indirectly made partners of the partnership firms without any monetary payments. In view thereof, ITAT rejected the contention that the receipt of assets by the trust was without consideration.

Further, ITAT also rejected the contention of the taxpayer that the firm received the said assets in a fiduciary capacity by noting that there were specific provisions in the Act for taxation of discretionary trusts, and the law categorially provides for taxation of such trusts at the maximum marginal rate of tax.

• • Provisions of section 56(2)(x) not applicable to genuine transactions:

 The ITAT rejected this contention of the taxpayer basis its observation that the amount was received without consideration for the benefit of non-relatives and the trust (i.e., existing and future beneficiaries) indirectly becoming partners in a firm in which the settlor was a partner. The ITAT opined that interest in the partnership firm was transferred to the trust to circumvent the provisions of section 45 and avoid capital gains exposure arising on the transfer of capital assets.

• • Invocation of Section 263:

The ITAT opined that the Income Tax Officer had not made requisite enquiries or applied mind while concluding the initial assessment. Further, ITAT observed that applicability of provisions of section 45(4), on reconstitution of the partnership firms, were not seen by the Income tax officer and hence invocation of section 263 proceedings was justified as order of the Income Tax officer was erroneous and prejudicial to the interest of the revenue.

The ITAT ruled against the taxpayer and held that the assets of INR 669.27 crores settled into the trust are taxable under section 56 (2)(x) as income from other sources.

5. KNAV Comments

•  In the wake of the current ruling, there is a possibility that even if all current beneficiaries of a discretionary trust are relatives, the trust may be taxed upfront if the trust deed simply provides the trustees the freedom to add non- relatives at a later date.
• The ruling of the ITAT underscores the critical importance of drafting in trust deeds, particularly when structuring them for succession or family planning. It also highlights the need for careful alignment with tax laws to avoid potential litigation and reassessment risks.
• Also, ITAT seems to have placed an emphasis on monetary consideration as “consideration” rather than the term “consideration” being defined in section 2(d) of Indian Contracts Act, 1872, and judicial precedents held under the erstwhile Gift-tax Act, which also covered non-monetary consideration as “consideration” (e.g., an act to do promise, abstinence, or promise is called a consideration for the promise).
• The decision also raises critical questions about the inclusion of partnership interests under the scope of shares and the applicability of the principles of noscitur a sociis. The outcome of this litigation should be interesting, and future judicial interpretations will be pivotal in resolving these issues.

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