ITAT Chennai Ruling Clarifies Equity Transfers to Private Trusts for Relatives are Not Taxable Under Section 56(2)(x)

Income Tax Appellate Tribunal (ITAT) Rules in Favour of Private Trust

The ITAT Chennai has delivered a significant ruling that equity shares transferred to a private trust exclusively for the benefit of relatives are not taxable under Section 56(2)(x) of the Income Tax Act.

Private Trust Overview A private trust is a legal arrangement where an individual (settlor) transfers assets to a trustee, who manages them for the benefit of designated beneficiaries. This formalises the transfer and ensures assets are used solely for the intended individuals.

Case Background In September 2021, Srinivasan created a private trust and transferred Rs 15.78 crore worth of equity shares to it. The trust claimed the transfer was tax-free under Section 56(2)(x). However, the Income Tax Department disagreed, treating the value of shares as taxable income under 'income from other sources'. The trust challenged this decision, and the matter went to the ITAT Chennai.

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ITAT Ruling The ITAT ruled in favour of the trust, holding that the actual purpose and structure of the trust, not hypothetical possibilities, matter. Since the trust was genuinely created for the benefit of relatives, the transfer of shares qualified for exemption under Section 56(2)(x).

Tax Benefits of Private Trusts Private trusts offer several tax benefits, including:

• Exemption from capital gains tax when transferring assets into an irrevocable trust (under Section 47(iii))
• The trust takes over the original purchase cost and holding period of the asset (under Sections 49 and 2(42A))
• Taxation in the hands of the trustee at slab rates applicable to each beneficiary (under Section 161)

Forming a Private Trust Setting up a private trust involves identifying the settlor, trustee, and beneficiaries, drafting a trust deed, and transferring assets into the trust. Careful drafting and clarity of intent are crucial to avoid legal complications and adverse tax consequences.

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