Can there be a way out of CBDT circular for taxability of AIFs?

SEBI in 2012 introduced its regulations on alternative investment fund where it categorized
various kind of investment vehicle used in India to pool up funds and invest in Indian entities.
The authorities very cleverly clarified the taxability of venture capital fund after the Finance
Act 2012; however, the private equity funds, debt funds, hedge funds etc. are still struggling
under the taxability regime of representative assessee provided under chapter XV of the
Income Tax Act [Act]. According to section 160 of the Act a trustee will be typically
considered as the representative assessee of the trust and he will be taxed on behalf of the
beneficiaries of the trust. The manner and extent of the liability of the representative assessee
will be in line and to the extent of the liability of the beneficiaries. However, if such income
is the profits of the business then the trust will be taxed at Maximum Marginal Rate of
33.99%1. So far is the story in case of the determinate trust. The matter of contention lies with
regard to the indeterminate trust. In cases where it is difficult to determine the beneficiaries of
a trust through the trust deed, the Assessing Officer will go on to tax the trust as the assessee
at the Maximum Marginal Rate and the extent of liability will not be restricted to the
unknown and unidentifiable beneficiaries. It is not mandatory that the representative assessee
be taxed; the Assessing Officer can proceed against the beneficiaries as well and refuse to tax
the representative assessee.
Typically in investment funds the trust deeds are made ahead of time and the contributors are
added to the trust as the beneficiaries on later date. In such cases the problem lies with
identifying the trust as determinate or indeterminate trusts.
CBDTs recent Circular
CBDT has already released a circular in 2014 that was supposed to bring clarity to the issue
of taxability, however it cannot be said that the issue is settled yet. The circular dated July 28,
2014 has provided that the in case of Alternative Investment Funds, not in nature of venture
capital fund, if the trust deed itself does not provide for the name of the contributors as the
beneficiaries, then in such cases the trust will be treated as indertminate trust and the tax
treatment will be done accordingly. Before the CBDT circular coming into picture, the most
authoritative decision on this matter was the Advance Ruling dated August 14, 19962. Where
the authorities accepted the contention that even if the trust deed did not mention the name of
1 Section 161(1) of the Act

the beneficiaries in the trust deed itself, but it made the provision of inclusion of contributors
on satisfying some conditions on later date, such trust will be considered as determinate trust.
The deed should also lay down the share of income that will be receivable by such
beneficiaries on future date. This judgment seemed reasonable in light of investment
opportunities being afforded to the investors. However, the CBDT circular demands change
in this aspect.
Bangalore Tribunal following earlier advance ruling
Bangalore income tax tribunal did mention the CBDT circular in its recent ruling of DCIT v.
India Advantage Fund VII,3 wherein it disregarded the circular as it did not relate to the
assessment year of the Assesse. The judgment followed the earlier stance in the AAR ruling.
In the instance case a trust was created by M/s. ICICI Venture Funds Management Company
Limited, where M/S. the Western India Trustee and Executor Company Limited were
appointed as the trustees of the trust by virtue of the indenture of trust. The trustees had the
power to call for the contributors who had to contribute an initial sum for the purpose of
investment. The trustees also entered into an agreement with each such contributor and the
contributors were identified as the beneficiaries. The bone of contention of the Income Tax
authorities was that the trust was a discretionary trust as at the time of formation of the trust
deed the names of the investors were not mentioned. The tribunal relied on the Advance
Ruling dated August 14, 1996 along with the judgment of CIT v. P. Sekar Trust4 so as to
understand what constitutes as determinate trust. The reasoning of the advance ruling and
Bangalore tribunals judgment has been highly influenced by the aforementioned decision.
Yet, when one consider the Madras tribunals decision it can be seen that in that case the
parties did not contend the fact that the parties were not identifiable. The trust deed had very
clearly pointed out that on the circumstance the beneficiaries get married, and then the
number of beneficiary will increase. So essentially the trust deed might not have specifically
named who is the beneficiary but it did point the description of the person who will be
beneficiary in the future date. The income tax tribunals has always equated such cases with
2 1997 224 ITR 473 AAR
3 ITA No.178/Bang/2012
4 321 ITR 305 (Mad)

that the clauses in the trust agreements where the discretion of accepting beneficiaries are
given to the trustees on fulfillment of the condition. However, the trust deed in cases of the
investment scheme does not in actuality provide the description of the beneficiary; it just
keeps the option open to choose the beneficiary. The intention of section 164 of the Act is
itself defeated by blindly equating the two cases. The inclusion of spouses or the children of
the already existing beneficiaries on the future date cannot be equated with including any
Person on fulfillment of the mere condition of some monetary benchmark. As in the later case
it can still be unknown who all were the beneficiaries and was for how long as in these
investment scheme the contributors may exit such scheme in very short period of time and
new contributors may come and go. In light of such circumstance, from the point of view of
the Income Tax authorities, the CBDT circular will minimize the chances of such revenue
loss.
The case analyzed that intention of drafting section 164 is to avoid the loss of the revenues
and it is on the tax authorities to choose whether they tax the beneficiary or the trust. Once
such choice is made the authorities cannot go back to their decision.5 Section 166 envisages
this option. In the case decided by the Bangalore tribunal, the beneficiaries had already filled
their individual tax return with the authorities and thus the income of the fund was already
taxed in the hands of the investors. It is said in light of Neela Productions v. CIT 6 and DCIT
Vs. Manilal Bapalal Family Benefit Trust7 the argument will not be of much help and the
wrong assessment can be cured by assessing the right person.
Revocable transfer- Can it be the way out?
The case discusses a very important aspect that can provide a leeway to these trusts so as to
avoid the CBDT circular.The tribunal analyzed the trust deed and the contribution agreement
between the parties and concluded that the contribution of the beneficiaries to the trust were
in the nature of revocable transfer. The income that arises out of the revocable transfer will be
taxed in the hands of the transferor.8 The contributors in the case had to transfer certain
amount at the time of inclusion of such contributor to the fund. There was general right to
5 Circular No.157 dated 26.12.1974 of CBDT
6 [1997] 223 ITR 504
7 66 ITD 179 (Mad)

terminate the agreement in the event the minimum fund commitment is not received and
specific right to terminate the agreement at the insistence of the investment manager. Tribunal
construed this provision to be in parlance with the definition of revocable transfer provided
under section 63 of the Act. Thus a simple clause in the agreement granting the termination of
the fund can go on to help the investor to claim the assessment to be done under Section 61 of
the Act.
At the end when all is said and done the CBDT circular has indeed given clarity on the issue
of taxability. It says that section 166 will not be invoked when the fund is already taxed as
representative assessee. However, if the assessment of the individual investor, who is named
and his shares defined in the trust deed, is carried before the assessment of the trustee then in
such cases what will happen to the income of the fund. Will the whole income be taxed again.
In light of High court of Gujrats view in Panna Sanjay Trust v. Commissioner Of IncomeTax9 where the court decided that if the definite beneficiaries share has already been assessed,
then the trust will be taxed on the remaining amount excluding the share of the definite
beneficiary. Thus essentially, funds should make their trust deed as definitive as possible
naming the beneficiaries and their respective share. However, if they cannot include the name
of all investors, then in such cases it would be advisable to separately beforehand submit for
assessment the individual income of those investors who are already named in the trust deed.
They are right assessee and Income Tax authorities cannot insist on taxing them on the
Maximum Marginal Rate.

8 Section 61 of the Act.

9 1969 74 ITR 396 Guj