Trust structures are increasingly gaining popularity for wealth and succession planning in India where most businesses are family driven. Increased global business opportunities have led business families, particularly the younger generations, to migrate and obtain residential status in foreign countries. In such a scenario, the aspects concerning Foreign Exchange and Management Act, 1999 (FEMA), particularly related to foreign direct investment (FDI) as incorporated under FEMA (Non-Debt Instruments) Rules, 2019 (NDI rules), are critical to assess.
Often in a family run business, the settlor (usually the family head), may wish to vest shares that he holds in a company to a trust for the benefit of family members (who may be resident or non-resident). Generally, trustees are elderly family members, who also may also be resident or non-resident. Thus, it is imperative to assess if NDI rules allow such vesting of shares of Indian company in a trust with non-resident trustees or beneficiaries.
Residential status of trust
Generally, the NDI rules prohibit receipt of investment from a person resident outside India, except as otherwise provided. A trust is not included within the definition of person, as provided under FEMA read with NDI rules. Further, courts have held that unlike a corporation (which is an artificial person), a trust is not a person but is merely an obligation/confidence vested on trustees to use the trust property for the benefit of the beneficiaries. Accordingly, it becomes practically difficult to accord any residential status to the trust independently. Therefore, the residential status of trustees and beneficiaries may have to be examined, for assessing residential status of trust.
Whose residential status matters?
Under the Indian Trust Act, 1882, the trustee is empowered to manage and administer the trust property as that of its own. This enables the trustee to exercise voting and other rights attached to shares, and therefore the trustee as such is construed as the legal owner of the shares. However, as the trustee cannot enjoy the benefits of the trust’s property, he is required to distribute any return/income on shares (such as dividend, buy back proceeds) to the beneficiaries. To this limited extent, the position of a beneficiary is akin to a beneficial owner of the shares.
As per NDI rules, where a declaration under Companies Act, 2013, regarding “beneficial interest” being held by a person resident outside India has been made, then, even if the investment comes from a resident, the same is construed as foreign investment. This indicates that for NDI rules, the residential status of the beneficial owner is relevant as against the residential status of legal owner.
However, “beneficial interest” under Companies Act, 2013, (as explained under section 89 (10)) is not limited to entitlement over dividend/other proceeds but includes the power to exercise other rights as well. Therefore, the emphasis placed on beneficial interest under the NDI rules may not be strictly applied to beneficiaries of trust. Accordingly, whether relevance should be placed on the residential status of trustee or beneficiary, may not be conclusively stated under NDI rules.
Requirement of approval
Courts, while interpreting the provisions of Gift Tax Act, 1958, have held that trust property is a gift made by settlor (donor) in favour of both trustee and beneficiary (donee(s)). The trustee holds the gifted property for the benefit of the beneficiary. Under the NDI rules, gift of equity instruments by a resident to a non-resident requires prior approval of Reserve Bank of India. This approval is likely to apply in case of creation of trust with a non-resident trustee or beneficiary. Nevertheless, as the NDI rules do not specifically allow the vesting of shares in a trust with non-resident trustees or beneficiaries, obtaining such approval seems a prudent approach.
In the present era of globalization, the lack of clarity in provisions may act as a roadblock is using trust structures for wealth and succession planning. To obviate ambiguity surrounding trust structures, the government should consider issuing requisite clarification under NDI rules.
Harish Kumar is a partner and Itee Singhal is a senior associate at L&L Partners
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