1986 (7) TMI 131 - AT - Income Tax

Summary

Issues:
Interpretation of Explanation (1) to section 164 of the Act regarding tax liability for discretionary trusts.

Analysis:

Issue 1: Interpretation of Explanation (1) to section 164 of the Act
The case involved a private trust created for the benefit of certain children, with the income to be distributed equally among them. The Income Tax Officer (ITO) assessed the trust's interest income at the maximum marginal rate, citing that the beneficiaries were not known or specified at the time of trust creation. The Appellate Assistant Commissioner (AAC) upheld this decision, stating that the shares of beneficiaries were indeterminate at the time of trust creation. The assessee contended that the beneficiaries were clearly determinate at the end of each financial year, as specified in the trust deed. The key contention revolved around the applicability of Explanation (1) to section 164 of the Act, introduced to curb tax avoidance through discretionary trusts.

Issue 2: Application of Explanation (1) to determine tax liability
The tribunal analyzed the provisions of the trust deed, particularly clause (4), which clearly specified the share of each beneficiary and identified the beneficiaries as the children of a specific individual, to whom the income was to be distributed equally. The tribunal highlighted that for the trust to be considered non-discretionary, two conditions must co-exist: clear specification of beneficiaries' shares and their identifiability as per the trust deed. Referring to a circular explaining the interpretation of the Explanation, the tribunal concluded that the trust in question met these conditions, as the beneficiaries were identifiable based on the trust deed's provisions. Therefore, the tribunal held that the trust did not fall under the purview of the Explanation and the income was chargeable at an appropriate rate, not the maximum marginal rate.

Conclusion:
The tribunal allowed the appeal, ruling in favor of the assessee, emphasizing that the trust's income should be taxed at an appropriate rate, not the maximum marginal rate. The decision was based on the clear specification of beneficiaries' shares and their identifiability in accordance with the trust deed, which exempted the trust from the provisions of Explanation (1) to section 164 of the Act.