Bangalore Tribunal ruling on Discretionary Trust and Partnership Firm Interest 

Background of the case

In a recent ruling, the Bangalore Income-tax Appellate Tribunal (‘the Tribunal’), in the case of Buckeye Trust¹, examined the taxation of a discretionary trust where the trustee has discretion to add beneficiaries other than relatives of the settlor. Further, the Tribunal ruled that “interest in a partnership firm” falls within the scope of “shares and securities” under section 56(2)(x) of the Income-tax Act, 1961 (“IT Act”).

The judgment has significant implications on the interpretation of private discretionary trust deeds and the taxation of contributions made by a settlor.

Facts of the case

• Buckeye Trust, a private discretionary trust, received an interest in a partnership firm worth approximately ₹670 crore.
• The transfer occurred pursuant to a settlement in favour of the Trust by a settlor.
• The deed granted the trustee discretion to include any person as a beneficiary (even individuals other than the settlor’s relatives).

Key Issues

1. Classification of Partnership Interest as Shares and Securities

Whether the interest in the partnership firm qualifies as “shares and securities” under Section 56(2)(x) of the IT Act.

2. Applicability of Section 56(2)(x)

Whether the transfer of partnership interest to the trust without consideration should be taxed under Section 56(2)(x) if the trust beneficiaries include non-relatives of the settlor.

Key Takeaways

1. Taxation of Partnership Interest When Trust Has Non-Relatives as Potential Beneficiaries

• The judgment reinforces that a trust allowing non-relatives as potential beneficiaries cannot claim exemption under Section 56(2)(x) for contributions received from the settlor, since the benefit is not restricted to relatives only. In the said case, the Tribunal emphasized that the wide wording of the trust deed disqualified the trust from exemption.
• The Tribunal also rejected the argument that the transfer occurred in a fiduciary capacity.

2. Whether Partnership Interest Falls Within “Shares” under Section 56(2)(x)

• The Tribunal interpreted the term “shares” broadly to include partnership interests, noting it is not limited to shares of a company.
• The Tribunal rejected a literal reading of “shares and securities,” holding that “and” should be read as “or”, enabling the provision to cover partnership interests and other forms of ownership aligning with the legislative intent.

Conclusion

The decision underscores the importance of review of various terms while drafting a trust deed from a tax perspective, and particularly when structuring them for succession and estate planning. The interpretation that the partnership interest shall be within the purview of definition of “Shares” under the IT Act, will be a subject matter of further consideration at a higher forum. The said judgement had been recalled by the Tribunal on 7 January 2025 and posted it for fresh hearing on 19 February 2025.

1. TS-958-ITAT-2024(Bang) ↩︎