The said gentleman was also worried that his wife might not be looked after by his children after his demise.
Aboobaker suggested the gentleman make a trust, where he could declare which child would get which asset and in what proportion. He and his spouse would be the primary beneficiaries of the trust and after his death, his spouse would be the sole beneficiary, with the children as successor beneficiaries. This would make sure the couple have complete control over their wealth during their lifetimes.
As a primary beneficiary, the person would, of course, be taxed at the slab rate but he would have complete control over the wealth distribution.
In another case, a person, in his early 40s, diagnosed with cancer, set up a trust to protect his assets for his child's future. He feared his wife might remarry; his child might suffer if his wife had to share the wealth with her future husband and/or another child. A year ago, this person set up an irrevocable trust in which both the wife and son were beneficiaries. He added a clause that his wife wouldn't get his wealth if she remarried.
As the trust route to succession planning gains popularity in India, the rich are increasingly looking at asset protection, rather than saving on taxes or passing on wealth to the next generation. The reason: "Primarily, wealth has grown manifold in most cases, as real estate and other asset prices have zoomed. This has led to increased complications on the succession front. For instance, till some years ago, the children of south Mumbai residents thought their parents had made a mistake by investing in real estate in Thane or Navi Mumbai. Today, the same children are interested in having a share in those properties. Also, business risks and the number of divorce cases have increased and the cost of litigation has risen. No one wants to lose his/her hard-earned wealth in litigation," says Aboobaker.
According to a Barclays Wealth Insights report, as on November 15, 2011, 61 per cent of family disputes in India were due to wealth distribution.
Succession can also be planned through a will. But if it involves real estate, a will can be contested and requires to be probated. However, trusts cannot be contested, nor do these have to be probated. And, trusts can function even when one is alive but a person's will comes into effect only after his/her death. Trusts are of various types - revocable and irrevocable (non-discretionary and discretionary). In India, irrevocable trusts are the most common. In some cases, a revocable clause is applied after the death of the settlor, who wants the beneficiaries to take a call on asset distribution.
"Trusts can also help insolvency protection. In this case, only an irrevocable non-discretionary trust can be set up and the settlor cannot be a beneficiary. If the settlor is a beneficiary, the share of the trust's assets belonging to the settlor or beneficiary can be attached in case of bankruptcy. Here, the beneficiaries also need to be defined," says Gautami Gavankar, senior vice-president and principal advisor (estate planning), Kotak Mahindra Trusteeship Services.
A trust has to have at least two trustees at a time. Most Indian families or private trusts have two members, usually the settlor and a family member. A trustee provides services such as managing the assets, handling legal and regulatory requirements and filing tax returns. "It is advisable to have a corporate trustee as a professional and neutral party. The corporate trustee makes sure the wishes of the founder or settlor as per the trust deed are fulfilled," says Aboobaker.
Gavankar says, "Ensure you've done succession planning for the trustees as well, so that the trust can function seamlessly if a trustee passes away. That's why having a corporate trustee is preferred because they have a perpetual succession plan in place." She recommends an odd number of trustees for better decision-making and distribution of power. One can change the trustees at any point.
Needless to say, creating a trust comes at a price - estate planning firms may charge either a percentage of the assets moved to the trust or a fixed fee. On average, such costs are Rs 5 lakh or more. It is advised to not transfer real estate to a trust directly, as this would attract stamp duty and registration cost for the trust; this could be a huge amount. Stamp duty varies from state to state. Though shares of unlisted companies, if held in physical form, also attract a 2.5 per cent tax, this cost would be less than the stamp duty on property price. The recurring costs are a payment to trustees for their services and maintenance of the trust. With complexities in the structure of the trust, costs increase even up to Rs 10 lakh. Sometimes, the cost of forming a trust can be charged as a percentage of the assets. That's why, though anyone can form a trust, it doesn't make sense for those with net worth of less than Rs 50 lakh. Nowadays, as the number of salaried individuals settling abroad is increasing, many are taking the trust route to avoid their children being taxed on income from their assets. Say, your son is a non-resident Indian; you form a trust and transfer all your wealth to it. Though India does not have inheritance tax, countries like the US impose estate duty on transfer of taxable assets. The trust would reduce your son's tax liability, as the ownership of the property stays with the trust and your son is only a beneficiary.
Also, with divorce cases on the rise, many estate planners are recording cases in which a person forms a trust as soon as he/she files for divorce - the aim is to protect their wealth for their children, who are made beneficiaries. In the case of minor children, the spouse can be made a beneficiary. Some parents also use the trust route to avoid their child parting with assets due to a bad marriage. The ownership of the asset lies with the trust, not the child - returns from the assets can be in the child's name. This ensures the child loses just a part of the returns, which is much lower than the value of the assets.
Parents of a child with special needs should set up a trust to provide for the child's care, in case something untoward happens to them.
THE TRUST FACTOR
What is a trust?
Through a private trust, assets or wealth are transferred by one party (settlor) to be held by another party (trustee) for the benefit of a third party (beneficiaries), under the Indian Trusts Act, 1982
Types of private trusts:
Revocable: This is an alternative to a will. It does not protect assets, as these can be withdrawn from this trust. Here, assets are not considered given away; so, these are taxed at the hands of the settler, at the slab rate. The settlor can be the beneficiary
Irrevocable non-discretionary: Assets cannot be withdrawn from here. The settlor has complete control of the trust norms. He/she decides which beneficiary receives which assets, and in what proportion. The settlor can be the beneficiary and after him/her, the child/children can be the beneficiary. If the settlor is the primary beneficiary, he/she is taxed at slab rate
Irrevocable discretionary: Here, the settlor lets the trustees decide which beneficiary gets which asset and in what proportion. The settlor only decides the beneficiaries. In this case, the beneficiaries can save on income tax from the assets till the time they don't know how much they would receive
HOW TO FORM A TRUST?
- You can make one with the help of a legal firm or a bank
- A trust document has to be prepared and this should state the type of trust it would be
- It should clearly state the name of the settlor, the trustees and the beneficiaries, as well as a list of all the assets the trust would hold
- Apply for a permanent account number for the trust and open a bank account for it as it is a separate entity
- Gift your existing investments to the trust
- If you wish to continue the investments, instruct your bank to debit the trust's account instead of your personal account
- The trust may or may not be registered; registration is required only if an immovable property is transmitted to the trust or bought through it
- Trust documents need not be made on stamp paper; plain sheets would suffice
HOW MUCH DOES A TRUST COST?
Through trust companies: Rs 5 lakh or more
Through lawyers: Lawyers charge on an hourly basis
Banks: 0.5 to 5% of the asset cost
Annual maintenance fee: Varies according to the trust structure
Corporate trustee fee (if at all): Varies according to the trust structure