Navigating Trusts: Understanding Composition, Registration, Structure, and Tax Effects

INTRODUCTION

Anyone can create a trust in India. The Indian Trust Act, 1882 (‘Act’) governs the private trusts established in India. This Act is applicable to the whole of India. But, it does not apply to the Waqf, mutual relations of the members of an undivided family determined by any customary or personal law and religious or charitable endowments. Public trusts in India are usually governed by state-specific legislation, such as The Maharashtra Public Trust Act, 1950.

What is a Trust?

In simple words, a trust is nothing but a transfer of property by the owner to another person in whom the owner has confidence for the benefit of a third person.

The property doesn’t just mean real estate. It could be cash, shares or any other valuable asset. Further, the instrument by which this entire trust is declared/created is called “the instrument of trust” or the “trust deed”.

Who can create a Trust?

A trust may be created by:

• Every person who is competent to enter into contracts: This includes an individual, AOP, HUF, company, etc.
• If a trust is to be created by on or behalf of a minor, then the permission of a Principal Civil Court of original jurisdiction is required

Objectives of a Trust

The main objective is that the trust should be created for a lawful purpose.

So how do we actually understand as to whether the purpose is lawful or unlawful? The answer to it lies in Section 4 of the Act. As per Section 4, all purposes are said to be lawful unless it:

• Is forbidden by law
• Defeats the provisions of law
• Is fraudulent
• Involves injury to another person or his property
• Immoral or against to public policy

Types of Trusts

1. Private Trusts: A private trust is for a closed group. In other words, the beneficiaries can be identified. Eg: A trust created for the relatives and friends of the author.
2. Public Trusts: A public trust is created for a large group, i.e. the public in large.
3.  Charitable trust: A trust established for charitable purposes, such as education healthcare, or poverty alleviation.
4. Religious trust: A trust established for religious purposes, such as the maintenance of a temple or mosque.

Criteria and Eligibility to Register a Trust

1. Minimum two trustees: A trust must have at least two trustees.
2. Settlor and beneficiary: The settlor and beneficiary must be clearly identified.
3. Trust deed: A trust deed must be executed, outlining the terms and conditions of the trust.
4. Registration: The trust must be registered with the relevant authorities, such as the Charity Commissioner or the Registrar of Trusts.
5. No ulterior motive: The trust must not be established for an ulterior motive, such as tax evasion or money laundering.

Documents Required for Trust Registration

1. Trust deed: A trust deed outlining the terms and conditions of the trust.
2. ID proof: ID proof of the settlor, trustees, and beneficiaries.
3. Address proof: Address proof of the trust’s registered office.
4. No-objection certificate: A no-objection certificate from the local authorities.
5. Payment of registration fee: Payment of the registration fee, as applicable

Procedure for registration

Form 10A is the form used to register a trust in India

12AA. (1) The Principal Commissioner or Commissioner, on receipt of an application for registration of a trust or institution shall—

 (a) call for such documents or information from the trust or institution as he thinks necessary in order to satisfy himself about, —

  (i) the genuineness of activities of the trust or institution; and

  (ii) the compliance of such requirements of any other law for the time being in force by the trust or institution as are material for the purpose of achieving its objects,

and may also make such inquiries as he may deem necessary in this behalf; and

 (b) after satisfying himself about the objects of the trust or institution and the genuineness of its activities as required under sub-clause (i) of clause (a) and compliance of the requirements under sub-clause (ii) of the said clause, he—

  (i) shall pass an order in writing registering the trust or institution.

  (ii) shall, if he is not so satisfied, pass an order in writing refusing to register the trust or institution, and a copy of such order shall be sent to the applicant :

Provided that no order under sub-clause (ii) shall be passed unless the applicant has been given a reasonable opportunity of being heard

Section 11 of the Income Tax Act, 1961, provides exemption from income tax for income derived from property held under trust for charitable or religious purposes.

Conditions for Exemption

1. Registration: The trust must be registered under Section 12AA of the Income Tax Act, 1961.
2. Charitable or Religious Purpose: The trust must be created for charitable or religious purposes.
3. Income Applied: At least 85% of the income derived from the trust property must be applied for charitable or religious purposes.
4. Accumulation of Income: The trust can accumulate up to 15% of the income derived from the trust property, subject to certain conditions.

Types of Income Exempt

1. Income from Property: Income derived from property held under trust, such as rent, interest, and dividends.
2. Voluntary Contributions: Voluntary contributions received by the trust, such as donations and grants.

Conditions for Accumulation of Income

1. Up to 15%: The trust can accumulate up to 15% of the income derived from the trust property.
2. For Specific Purposes: The accumulated income must be used for specific purposes, such as education, healthcare, or poverty alleviation.

Consequences of Non-Compliance

1. Loss of Exemption: If the trust fails to comply with the conditions for exemption, the exemption may be withdrawn.
2. Tax Liability: The trust may be liable to pay tax on the income derived from the trust property.

Important Notes (Compulsory requirement for claiming exemption)

1. Registration Certificate: The trust must obtain a registration certificate from the Commissioner of Income Tax and is valid for 5 Years However Budget 2025 extended the validity of registration to 10 Years giving less burden.
2. Annual Return: The trust must file an annual return of income with the Income Tax Department.
3. Audit Requirements: The trust may be required to undergo an audit, depending on the level of income and other factors.
4. Maintenance of Accounts: The trust must maintain proper accounts and records

Tax Rates for Trusts (Section 164)

Up to 2,50,000- Nil

2,50,001-5,00,000- 5%

5,00,001-10,00,000-20%

Above 10,00,000- 30%

Penalties in case of Trust:

1. Penalty for Non-Registration: Failure to register a trust under Section 12AA of the Income Tax Act may result in a penalty of ₹10,000.
2. Penalty for Non-Filing of Annual Return: Failure to file an annual return under Section 139(4) of the Income Tax Act may result in a penalty of ₹5,000 to ₹10,000
3. Penalty for Non-Compliance with Trust Deed: Failure to comply with the trust deed may result in a penalty of ₹10,000 to ₹50,000.
   1. Failure to apply income for charitable purposes may result in a penalty of 100% to 200% of the income

4. Penalty for Misuse of Trust Funds: Misuse of trust funds may result in a penalty of 100% to 200% of the income.
5. Penalty for Non-Compliance with GST Provisions: Failure to comply with GST provisions may result in a penalty of ₹10,000 to ₹50,000.
6. Penalty for Non-Compliance with TDS Provisions: Failure to deduct tax at source (TDS) may result in a penalty of ₹10,000 to ₹50,000.

Audit is mandatory for trusts in certain circumstances:

Mandatory Audit:

1. Income exceeding ₹1 crore
2. Claiming exemption under Section 11
3. Registered under Section 12A

(Note: Section 12AA is a more comprehensive and stringent provision for registration of trusts and institutions, while Section 12A is an older provision with less stringent requirements

Sec12A: Applies to trusts and institutions established before April 1, 1962

Sec12AA: Applies to trusts and institutions established on or after April 1, 1962)

Voluntary Audit:

1. Trusts with income below ₹1 crore
2. To improve internal controls

Sec 10(23C) of Income Tax Act

If trust gets approval Under section 10(23C) of income Tax Act as Education institutions, Hospitals, and other organizations for specific purpose enjoys exemption from income tax on its income.

Benefits:

1. Tax Exemption: The trust enjoys exemption from income tax on its income.
2. Increased Donations: The trust may attract more donations, as donors can claim deduction under Section 80G.
3. Enhanced Credibility: Registration under Section 10(23C) enhances the trust’s credibility and reputation.

Compliance Requirements:

1. Annual Returns: The trust must file annual returns with the Income Tax Department.
2. Audited Accounts: The trust must maintain audited accounts and submit them to the Income Tax Department.
3. Compliance with Conditions: The trust must comply with the conditions of registration and approval.

Consequences of Non-Compliance:

1. Withdrawal of Exemption: The exemption can be withdrawn if the trust fails to comply with the conditions of registration and approval.
2. Tax Liability: The trust may become liable to pay income tax on its income.