Will an Indian beneficiary of a foreign trust face tax liability here?

I am an Indian citizen living in Dubai and own an immovable property in the US. Since the property is in the US, I want to set up a US trust for the benefit of my two sons. One son holds a green card and stays in the US, the other is an Indian resident. The property will be put out on rent and will pass on to my sons in equal share upon my demise. What will be the tax implications in India for any of us?

—Name withheld on request

I assume that you qualify as a non-resident under the provisions of the Income Tax Act, 1961 (ITA) and that the trust you intend to establish in the US will be a non-grantor trust. As a non-resident, transferring foreign assets into a foreign trust will not trigger any tax liability for you in India. Additionally, since the trust will be set up solely for the benefit of your children, one of whom is a tax resident of India, this transfer will not be considered a taxable event for the trust, even with respect to the share pertaining to your Indian resident son.

Under the ITA, trustees of a private trust act as representative assessees. For specific trusts, trustees are typically assessed in their own names for income explicitly earmarked for the beneficiaries. Tax on any income earned by the trust is levied “in the like manner and to the same extent” as it would be on the beneficiaries directly. However, when the shares of the beneficiaries are known, the income may be taxed either in the hands of the trustees (as representative assesses) or directly in the hands of the beneficiaries. In your case, the share of rental income attributable to your Indian resident son as a beneficiary will be taxable in India, either in the hands of the trustee or directly in his hands. Your non-resident son will not be liable to tax on his share of foreign rental income in India. As the settlor, you will also not have any tax liability in India on this income, as the trust will be an irrevocable trust.

Although the ITA does not expressly exempt the eventual distribution of trust assets to your Indian-resident son from tax, you may rely on judicial precedents to take such a position. Your non-resident son will not be liable to tax in India upon trust distribution too.

As a beneficiary, your Indian resident son will be required to disclose the details of the foreign trust in his Indian income tax return under Schedule FA (Foreign Assets). Any taxes withheld/paid in the US on the rental income can be claimed in India while filing ITR, subject to filing Form 67.

Considering the legal uncertainty under India’s foreign exchange law regarding cross-border trusts, it is advisable to seek professional advice before setting up such a trust with an Indian resident as one of the beneficiaries.

Harshal Bhuta is partner at P. R. Bhuta & Co. CAs