BACKGROUND

A trust will be regarded as a ‘Discretionary Trust’ if the trustees hold the power to decide the class of beneficiaries who can receive either capital or income from the Trust at the discretion of the Trustees. As per section 164¹  read with section 167B²  of the Income-tax Act, 1961 (IT Act), such Trusts are taxed at the "maximum marginal rate" (MMR) due to the indeterminate nature of their beneficiary structure. A question may arise as to whether the MMR would include the highest rate of surcharge or not. 

Recently, the Special Bench of the Mumbai Tax Tribunal³  had an occasion to analyse whether surcharge should be applied uniformly at the highest rate, regardless of the income earned, or in accordance with the slab-based thresholds specified in the relevant Finance Act. We, at BDO in India, have summarised this ruling and provided our comments on the impact of this decision hereunder:

FACTS OF THE CASE

The taxpayer, a Private Discretionary Trust, filed its tax return for the Fiscal Year (FY) 2022-23, declaring an income of INR 0.48 mn. The taxpayer paid tax at the MMR as per section 164, read with section 2(29C) of the IT Act. While processing the tax return, the Centralised Processing Centre (CPC) applied highest rate of surcharge.
Aggrieved, the taxpayer filed an appeal. The first appellate authority and the Mumbai Tax Tribunal ruled in favour of the tax authorities and held that highest rate of surcharge would be applicable on the tax computed at MMR. Further, considering that there were contrary views on this issue, the taxpayer filed an application for constitution of a Special Bench. 

SPECIAL BENCH MUMBAI TAX TRIBUNAL RULING

The Special Bench of the Tax Tribunal, while ruling that surcharge on income of Private Discretionary Trust is to be computed on the income tax having reference to the slab rates prescribed in the Finance Act, made the following observations:

• A Private Discretionary Trust is covered either under the provisions of section 164 or section 167B of the IT Act. Further, the said sections provide that the income of such Trusts will be taxed at the MMR. 
• The provisions of section 164 and 167B of the IT Act do not provide any reference to levy of surcharge. 
• ‘MMR’ as defined under section 2(29C) of the IT Act refers to the rate of income tax, including surcharge on income tax, if any, applicable to the highest slab of income of an individual, association of person or body of individual as specified in the Finance Act of the relevant year. 
• The aforementioned definition clause of ‘MMR’ by itself does not fix the rate of tax, instead, it refers to the rate prescribed under the Finance Act of the relevant year which are prescribed under section 2 of the Finance Act. 
• Section 2 of the Finance Act, 2023, provides that income tax shall be charged at the rate specified in Paragraph A, Part (I) of First Schedule to the Finance Act 2023, and such tax shall be increased by a surcharge.
• Section 2(3) of the Finance Act carves out an exception and provides that taxpayers covered under the provisions of section 164 or 167B of the IT Act shall be taxed at the rates specified in those sections. 
• In case of discretionary trusts, sections 164/167B of the IT Act do not by themselves specify the rate of tax. They only provide that tax on total income is to be determined at the MMR. The definition of ‘MMR’ under section 2(29C) of the IT Act, in turn, refers to the rate of income tax applicable to the highest slab as provided under the Finance Act of the relevant year.
• The expression ‘slab’ is neither mentioned in section 2(1) or even under Paragraph A, Part (I) of First Schedule to the Finance Act 2023. However, Press Note dated 1 December 1965 issued by the Government of India, provides that the expression ‘slab’ refers to ‘income’ and not the tax.
• Therefore, in accordance with sections 164/167B read with section 2(29C) of the IT Act, tax as per MMR would mean the rate of tax applicable to the highest slab of income under Item (1) of Paragraph A, Part (I) of First Schedule to the Finance Act 2023. As per Paragraph A, Part (I) of First Schedule to the Finance Act 2023, the MMR of tax will be 30%.
• Under the head ‘Surcharge on income-tax’ appearing in Paragraph A, Part (1), First Schedule, it has been provided that the amount of income tax computed as per the rate of income tax shall be increased by a surcharge, calculated in the manner provided therein. Items (a) to (e), under the head ‘Surcharge on income tax’, provides different rates of surcharge on income tax, depending upon the categories of income. The rate of surcharge ranges from a minimum of 10% to a maximum of 37%. Further, as per Paragraph A, Part (I) of First Schedule to the Finance Act 2023, the threshold limit for applicability of surcharge is when total income is INR 5mn and above. 
• Further, first proviso under the heading ‘Surcharge on income tax’ carves out an exception and provides that if the total income of a taxpayer includes any income by way of dividend or income under certain provisions of the IT Act, the rate of surcharge on tax computed on such part of income under no circumstances would exceed 15%.
• If the contention of the tax authorities is accepted that, irrespective of the nature or quantum of income, surcharge has to be computed at the highest rate of 37% applicable to the highest income bracket of INR 50mn and above, then the exception provided under the first proviso under the heading ‘Surcharge on income tax’ would become otiose. Even the different rates of surcharge on income tax provided under clause (a) to (e) applicable to the different slabs of income would become meaningless so far as discretionary trusts are concerned. Such an interpretation would lead to absurdity.
• Once the definition of ‘MMR’ refers to the rate of income tax and surcharge provided under the Finance Act of the relevant year, then the rates of income tax and applicable rate of surcharge as provided under Paragraph A, Part (I) of First Schedule to the Finance Act 2023, would apply. 
• The expression ‘including Surcharge on income tax, if any’, within the bracketed portion of section 2(29C) of the IT Act, would mean the surcharge as provided in the computation mechanism under the heading ‘surcharge on income tax’ finding place in Paragraph A, Part (I) of First Schedule to the Finance Act 2023.
• The expression ‘if any’ used in section 2(29C) has to be read not de hors but in conjunction with the computation mechanism provided under the heading ‘surcharge on income tax’ provided in section 2 of Finance Act. This view is further fortified by the object for which levy of surcharge was introduced in the Finance Act – to augment the Revenue of the Union for developmental work by asking persons in the highest income bracket to contribute little more than the other citizens, for nation building.
• Therefore, in case of Private Discretionary Trusts, whose income is chargeable to tax at MMR, surcharge must be computed on the income tax having reference to the slab rates prescribed in the Finance Act under the heading ‘surcharge on income tax’.

BDO INDIA COMMENTS

This is a welcome ruling as it has provided clarity in circumstances where trusts with relatively modest income levels have been subjected to the highest surcharge rates. It emphasises that surcharge must be applied based on slab-based thresholds, not at a flat maximum rate. While the decision is focused on private discretionary trusts, its rationale may influence the interpretation of surcharge provisions across other entities/ taxpayers where MMR is invoked.

Further, while coming to the above conclusion, the Special Bench has emphasised on harmonious interpretation of statutory provisions such that different surcharge rates as prescribed based on income, remain meaningful and prevent discriminatory taxation. Additionally, considering that the proposed Income Tax Bill 2025 defines MMR in the similar manner as defined under the IT Act, reference to this ruling can be made after enactment of the new IT Bill, provided that the trust taxation provisions remain unchanged.


¹Section 164 of the IT Act provides for the charge of tax where the share of beneficiaries is unknown.
²Section 167B of the IT Act provides for the charge of tax where shares of members in association of persons or body of individuals unknown, etc.
³Araadhya Jain Trust vs Income Tax Officer, (ITA No. 4272/Mum/2024)(Special Bench)