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The Liechtenstein Story!

Published on Fri, Nov 14,2014 | 22:50, Updated at Fri, Nov 14 at 23:12Source : CNBC-TV18 |   Watch Video :

The black money debate has been hogging the headlines. Secret lists of accounts, treaty bashing and what not. in all this noise, one tribunal decision stands out- for doing what courts rarely do. The Tribunal has allowed the revenue department to tax undisclosed income from a Liechtenstein trust. Payaswini Upadhyay gets you the story and the implications of this ruling.

Under the Income Tax Act, a discretionary trust has to pay a maximum marginal rate of 30% on its income before the Trustees distribute the income to the beneficiaries.

Krishnan Malhotra
Head – Taxation, Amarchand & Mangaldas
“Interestingly, in the event the trustees don’t pay the taxes, then there is no bar that the taxes can’t be recovered from the beneficiaries but the important point is so long the distribution is not taking place, the recovery from the beneficiaries is always a challenging situation. There are series of judgment, one from Gujarat High Court, which clearly says that so long the beneficiaries don’t receive the funds, don’t receive the distributed money from the Trust; the recovery on account of the taxes cannot be made from the beneficiaries.”

Mukesh Butani
Managing Partner, BMR Legal
“The question that arises is that in a discretionary trust, can you bring in to tax an income which has not been distributed and that’s where the principle laid down by the Supreme Court is you cannot bring that income to tax. The trigger to bring that income to tax is when the beneficiary actually receives the income.”

But the tax department chose to do quite the opposite in Manoj Dhupelia’s case. The department received information from Germany on a discretionary Trust in Liechtenstein. The information revealed that Dhupelia was a beneficiary of this discretionary trust which had a balance of 11.7 cr rupees in its bank account in Liechtenstein Bank. The tax department alleged that Dhupelia had failed to report his income from this discretionary trust and that part of the trust’s bank balance was on account of deposits made by Dhupelia.  The department hence added 25% of the account’s amount to Dhupelia’s income for tax purposes.

Dhupelia argued against the addition in income on 4 key grounds
-    The information based on which the tax department had made additions was not verified
-    He had not received any money from the Trust and his name was not among the Trust beneficiaries
-    The department had produced no evidence to conclude that he had made deposits in the name of the Trust.
-    And finally even if tax has to be levied, it should be on the interest income earned by the Trust in the relevant assessment years and not on the balance amount

Mukesh Butani
Managing Partner, BMR Legal
“What portion is this income is liable to tax? As you pointed out is it just the income earned or is it the income and the capital. Now that is a debatable issue whether the entire income including the capital component is liable to tax or not. Ordinarily people have been taking the position that that any income that you receive from a discretionary trust in the hands of the beneficiary is a capital receipt and hence not liable to tax.”

The Mumbai ITAT didn’t think so. The Tribunal relied on a 2008 report of the US Senate Subcommittee which had adversely commented on Liechtenstein secrecy laws and how they permitted tax avoidance. The Tribunal pointed out that Discretionary Trusts are created for the benefit of specific persons and even though they may not control the affairs of the Trust, they remain its sole beneficiaries. In saying so, the Tribunal concluded that the deposits made by Dhupelia in the bank account of the Trust is his unaccounted income and confirmed the additions made by the tax department.  

Krishnan Malhotra
Head – Taxation, Amarchand & Mangaldas
“he intention which is coming out of this ruling is that the tax authorities would be going after such trusts and such beneficiaries and this ruling also brings out that the judiciary – even the fact finding ones - are also not really going so much in detail in terms of investigating the facts or evidences but just relying upon authenticated documents received from foreign sources. And in defense, beneficiaries would not be able to bring enough records to justify their stand that this money doesn’t belongs to them or they have got to do nothing with it.”

Mukesh Butani
Managing Partner, BMR Legal
“I think there is going to be an element of anxiety in the minds of genuine offshore discretionary trusts as to what does this mean by way of binding principles and situations where ordinarily beneficiaries of such offshore discretionary trusts would not be liable to tax. But a plain reading of the judgment suggests that the Tribunal’s view was largely motivated by the manner in which the Trust was created, the fact that it could not conclusively establish that the asseessee was indeed the beneficiary and third and most importantly, this disclosure came as part of cracking funds lying in bank accounts overseas. So to a larger extent, the Tribunal’s view is predicated on this whole drive against black money and money being stashed away in foreign accounts etc.”

The decision may well have been predicated on the drive to bring the black money back, but it overlooks a recent Supreme Court precedent. As Mukesh Butani pointed out - In May this year, the apex court ruled that income of a discretionary trust cannot be taxed in the hands of a beneficiary unless it is distributed to the beneficiary. But this precedent finds no mention in the ITAT order. The other aspect that has baffled experts is that the Tribunal has based its ruling on non-disclosure of income and has failed to provide under what provision of the Income Tax Act the assets of the Trust were added to the taxpayer’s undisclosed income. The ruling has led to more questions than answers but has sent one message loud and clear that taxpayers would find it difficult to take shelter under the secrecy law of tax havens!

In Mumbai, Payaswini Upadhyay


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