Wednesday, March 29, 2023

Plugging the Holes of Swiss Cheese

The recent verdict of the apex court of Switzerland makes it viable for foreign governments to chase alleged tax evaders. India now has the information and the regulations. How the information is deployed and the law invoked will decide the wisdom or maturity of the tax administration

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By Shivanand Pandit       

In a monumental judgment, the Swiss Federal Supreme Court has pronounced that although persons who are final beneficiaries have not received any money from secret offshore trusts and numbered bank accounts, the Swiss authorities can still move ahead with communicating such confidential facts with India. The verdict pertains to foreign trusts in tax havens with manifold beneficiaries, some of whom are connected to big Indian business houses. This stand has crushed the hopes of many resident Indians. They were banking on the apex court of Switzerland to stop, or at least postpone, the transfer of data to the income tax department in India. However, this is a big win for Indian tax officials in the battle against black money.

Earlier committees engaged by rich Indians have presented their contentions before Swiss courts, mentioning that personal financial data of this kind is immaterial to the Indian tax department because the department cannot levy tax on the beneficiaries in the non-existence of any distribution of funds from foreign trusts. However, the apex court has laid down in numerous verdicts that it would not sit in the decision on why Indian authorities have demanded data and whether they can claim tax on the back of such data.

At one time, no information was shared in instances where demands were made on hidden information on wealth. Today, there has been a major transformation in the viewpoint of the authorities and courts of law. Now, the law is to communicate data and full confidence is put on the requesting nation in information-sharing procedures. Taxpayers will need to take vital arguments relating to the non-applicability of taxes on such arrangements in their home country.

In India, a few of the tax appellate benches have tried to segregate trusts and the beneficiaries on the grounds that the latter indirectly regulated the trust by selecting trustees who they appointed. The judgments may negate the legal remedy available to Indians or individuals of other nationalities with secret bank accounts and tax haven structures attempting to avert their respective governments from retrieving information on wealth. According to the Swiss Supreme Court, Switzerland will communicate data only if India pursues it without assessing the data’s ultimate significance and end-use.

A discretionary trust is one where the exact shares of the beneficiaries are not known. That is to say, the trustee has the choice to determine, from time to time, who (if anyone) among the beneficiaries is to benefit from the trust, and to what level. In a determinate trust, the right of the beneficiaries is fixed by the settlor. The trustees have no option in deciding the disbursement of the amount to be made to the beneficiaries. Remarkably, a customary arrangement deployed by wealthy Indian families to keep funds away from the income tax department’s detector is via “discretionary trusts”, where trustees have the option to distribute the income, capital gains, or principal amounts from the trust to the beneficiaries. Normally, such a trust holds shares of a company, incorporated in the same or in a different tax haven, having accounts with a Swiss Bank, while the family members are named as beneficiaries of the trust.

As per the provisions of the Income Tax Act, the income of a discretionary trust is taxed in the hands of the trustee while the income of a determinate trust may be taxed either in the hands of the beneficiary or the trustee in his capacity as the representative assesee. If it is the latter, the taxation in the hands of a trustee must be in the same manner and to the same extent that it would have been levied on the beneficiary. That is, the trustee would generally be able to avail all the benefits or deductions, etc. available to the beneficiary with respect to that beneficiary’s share of income.

Previously in 2014, the Supreme Court of India upheld the decision of the Gujarat High Court and decreed in the Commissioner of Wealth Tax, Rajkot vs Estate of Late HMM Vikramsinhji of Gondal that the taxpayer, a beneficiary of a discretionary trust, was not assessable, on the income of the trust till such income was disbursed by the trustees. This is a general rule, and the challenge before tax authorities is to prove the source. Any assumption that offshore trusts have illegitimate money would be biased.

As per the verdict, beneficiaries of a discretionary trust should not incorporate any share of the trust’s income in their individual tax returns unless it is actually received by them. Furthermore, according to the nature of the trust, the income of a trust and the income of a beneficiary will be assessed. The nature of the trust is decided by looking at the trust deed as a whole, backed by reports of the trustees’ resolutions and the trusts’ financial statements. The settlor must make sure that his intent as to the nature of the trust is lucidly revealed in the trust deed in clear language and trustees must maintain a record of their decisions and reasons for it.

One main concern that has not been tackled in the decision is whether it is only income distributions made by the trustee that would be taxed in India or even capital or corpus distributions from a trust to its beneficiaries that are taxable. This query rides on a consideration of whether the distribution can be classified to be in the nature of capital distribution that should normally not be taxed or if the same can be treated as “income from other sources” according to Section 56 of the Income Tax Act, 1961. As per the Section, the income received by an individual or Hindu Undivided Family from a person without consideration or for inadequate consideration (subject to meeting certain value thresholds) is chargeable to income tax under certain circumstances. Since a trust is not a “person” under the Income Tax Act, there has been discussion on whether this would cover situations where the trustee of a family private trust makes income distributions to family beneficiaries.

In this decision, the Supreme Court has mentioned that the beneficiary can be taxed on a receipt basis. Considering that it has not addressed the issue of capital receipt vs income receipt, it would be difficult to consider this decision as laying down a principle that all distributions by a discretionary trust to its beneficiaries once received are taxable in the hands of the beneficiaries.

After the Swiss court verdict, once the data enters India, the lengthy traditional fight between the income tax department and the individuals would start. The department would dispatch a new notice demanding tax on the amount lying in the trust and the persons affected would go on appeal. The process would move from the first appellate to the tribunal and then to the High Court. Thus, the litigation will be alive for at least five years. In all probability, as per the provisions of the draconian Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, the tax office may slap a distinct notice for the probable mistake in not revealing the foreign assets under the FA Schedule in the Income Tax return.

Now there is an anxiety that the tax department could retroactively use rigorous rules relating to black money to levy criminal sanctions. This highlights the necessity for tax officials to conclude the investigation quickly, leading to the closure of the case in a reasonable timeframe. Universally, the requirement is also to have a handbook of the actual beneficial owner of any trust or company. Every individual holder of financial securities, whether persons or juridical entities, should have a distinctive identifier so that the ultimate beneficiary can be identified, even if the person stays beyond a network of companies or trusts.

As a final point, the verdict of the apex court of Switzerland confirms the exchange of data agreement between the two nations in the revised tax treaty in 2011. The amendment came after Switzerland stopped banking secrecy laws, making it viable for foreign governments to chase alleged tax evaders. India now has the information and the regulations. How the information is deployed and the law invoked will decide the wisdom or maturity of the tax administration.

—The writer is a financial and tax specialist, author and public speaker based in Margao, Goa

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