1998 (2) TMI 113 - HC - Income Tax

Discretionary Trust Character Unchangeable; 65% Tax Rate Applies

The court held that the character of a discretionary trust cannot be changed by a resolution passed by the trustees. The Tribunal's decision was ... Discretionary trust - determinate or indeterminate shares of beneficiaries - representative assessee liability - charge under section 164(1) where shares are unknown or indeterminate - application of flat rate of sixty-five per cent. under section 164 - effect of trustees' resolution on the character of a trustDiscretionary trust - effect of trustees' resolution on the character of a trust - determinate or indeterminate shares of beneficiaries - The character of the discretionary trust vis-a-vis a trustees' resolution to pay net income to a single beneficiary. - HELD THAT: - The trust deed vested the trustees with absolute discretion to accumulate or to pay net income to one or more named beneficiaries in such proportions as the trustees thought fit; the beneficiaries' shares were not fixed in the instrument and were therefore indeterminate. The trustees' exercise of discretion by passing a resolution to pay the net income for a specified period to one beneficiary did not, by itself, convert the trust into one with determinate shares. The court held that the ability and power of trustees to disburse income to any beneficiary derives from the indeterminate nature of the shares as evidenced by the deed; a later distribution under that discretion does not retrospectively fix the beneficiaries' shares in the trust instrument. Accordingly, the trust continued to be a discretionary trust despite the resolution.The trustees' resolution did not change the character of the discretionary trust; the trust remained discretionary.Charge under section 164(1) where shares are unknown or indeterminate - representative assessee liability - application of flat rate of sixty-five per cent. under section 164 - Whether the Income-tax Officer was justified in applying the flat rate of 65% under section 164 of the Income-tax Act in respect of the trust's income. - HELD THAT: - Section 164(1) applied where income was not specifically receivable for the benefit of one person or where the individual shares of beneficiaries were indeterminate or unknown. Because the trust deed left shares indeterminate, section 164(1) was attracted even though trustees had by resolution paid net income to a single beneficiary; distribution under the trustees' discretion did not cure the indeterminacy arising from the deed. The court rejected the Tribunal's reliance on post-facto legislative Notes and the Explanation inserted from April 1, 1980, as unnecessary to decide the question on the statute as it stood for the relevant year. Reliance on precedent distinguishing trusts where shares could be determined from the instrument (e.g., Nizam's Trust) was held inapposite because, on the deed before the court, shares were not ascertainable. The Revenue therefore had the option to assess the trust as representative assessee and apply the flat 65% rate under section 164(1) as more beneficial to the Revenue.The Tribunal erred; the Income-tax Officer was justified in applying the 65% rate under section 164.Final Conclusion: Both questions in the reference are answered against the assessee: (i) the trustees' resolution did not alter the discretionary character of the trust; and (ii) the Income-tax Officer was justified in applying the flat 65% rate under section 164(1) for the assessment year 1979-80. Issues Involved:1. Whether the character of a discretionary trust can be changed by a resolution passed by the trustees.2. Whether the Appellate Tribunal was right in law in holding that the Income-tax Officer was not justified in applying the rate of 65 per cent under section 164 of the Income-tax Act, 1961.Detailed Analysis:Issue 1: Change of Character of Discretionary Trust by Trustees' ResolutionThe court examined whether a discretionary trust's character could be altered through a resolution by the trustees. The assessee-trust, formed under a deed of settlement dated March 27, 1961, was discretionary, allowing trustees to either accumulate or distribute the net income at their discretion. A resolution passed on January 24, 1976, directed the trustees to pay the net income to one beneficiary, Bharatidevi Sarabhai, for her absolute use and benefit. The court held that the representative assessee continued to be a discretionary trust despite this resolution. The shares of the beneficiaries were indeterminate or unknown as per the trust deed, and the trustees' discretion to distribute income did not alter the trust's discretionary nature. Thus, the character of the trust remained unchanged by the resolution.Issue 2: Application of Section 164 and the 65% Tax RateThe court considered whether the Appellate Tribunal was correct in holding that the Income-tax Officer was not justified in applying a 65% tax rate under section 164. The relevant assessment year was 1979-80. The Income-tax Officer assessed the trust at a 65% rate, arguing that the trust remained discretionary and the shares of the beneficiaries were indeterminate. The Tribunal had allowed the assessee's appeal by referring to its earlier decision without providing detailed reasons. The court emphasized that when relying on earlier decisions, the Tribunal should annex the reasoned order to aid judicial review.The court noted that under section 164, if the shares of the beneficiaries are indeterminate or unknown, the income is taxed either as the total income of an association of persons or at a flat rate of 65%, whichever is more beneficial to the Revenue. The court found that the trustees' discretion to distribute income did not make the beneficiaries' shares determinate. The trust deed did not specify the shares, and the trustees' resolution to pay income to one beneficiary did not change this fact. The court also referred to the Supreme Court's decision in CIT v. Kamalini Khatau, which held that the Revenue could assess either the trust or the beneficiaries.The court concluded that the Tribunal erred in holding that the Income-tax Officer was not justified in applying the 65% rate under section 164. The provisions of section 164 were applicable as the shares of the beneficiaries were indeterminate. The court answered the substantive question in the negative, in favor of the Revenue, and against the assessee.ConclusionThe court held that the character of a discretionary trust cannot be changed by a resolution passed by the trustees. The Tribunal was incorrect in holding that the Income-tax Officer was not justified in applying the 65% tax rate under section 164. The reference was disposed of with no order as to costs.