Ensure smooth transfer of wealth through a trust

Estate planning has become an area of priority for high net worth individuals (HNIs), as they wish to transfer their riches to the next generation without acrimony. There are two popular options, will and trust. The latest edition of Kotak Wealth Management’s ‘ Top of the Pyramid’ report says, a will remains the popular instrument of choice for bequeathing wealth but trusts are gaining traction.

A number of issues can arise when wealth is transferred through awill. This document can be easily challenged in a court. When a person dies after writing a will, his heirs need to get a certificate, called probate, from a court, saying the will is authentic and the heirs agree to abide by it. During the probate proceedings, inheritors can challenge the will. The probate certificate is issued only after the dispute gets sorted. This can delay the transfer of estate to the next generation.

No probate certificate has to be obtained in case of a trust.

“A will becomes effective after the death of the testator ( person who has made the will) and hence it can get challenged on various grounds, like the person did not know what was doing, he was of unsound mind, the will does not bear the signatures of the testator, or the signatures have been forged,” says Gautami Gavankar, principal advisor — estate planning, Kotak Mahindra Trusteeship Services.

With a trust, an HNI can put a succession plan in place during his lifetime. “ He can move assets into the trust, ensure it operates in a certain way, and specify the manner in which wealth is to be distributed. By the time of his death, a system is already in place and the chances of it being challenged become remote,” says Varghese Thomas, partner, J Sagar Associates.

A will comes into effect after an individual’s demise. But, what if he Uncertainty can arise over who will take care of his financial affairs in the interim. A Trust is a good solution for such a situation.

Many promoters of companies take significant loans. Some of them give personal guarantees against those loans. If the business incurs losses, the lenders could attach the promoter’s personal assets. “ If you don’t do any ringfencing, your assets are not protected. A Will could not protect your wealth in such a situation, while a trust, if appropriately created, may,” says Gavankar.

Trusts can also be used to ringfence wealth in other situations, as this example shows. A Delhi- based industrialist wanted to pass on his wealth to his daughter but was concerned that after she got married, her future husband would assume control of her assets. He transferred the assets into a Trust, naming his daughter and her future children as its beneficiaries. Ensuring that in amarital dispute, the son- in- law would not be able to make a claim on her wealth.

Globe- trotting HNIs also wish to guard against the eventuality of passing away early, while their children are still very young. They don’t want a huge amount of wealth to go into the latter’s hands when they are still immature. So, they set up a trust to manage the wealth until the children attain maturity.

There is anticipation that estate duty could be introduced in India. “The estate duty rate in most countries is close to the individual tax rate, which in the Indian context could be as high as 30 per cent. Lifetime transfer of assets into a trust is a common tool used across countries to mitigate the impact of estate duty,” says Bijal Ajinkya, partner, Khaitan and Co.

Stumbling blocks: Many HNIs are reluctant to set up a trust for two reasons. One is fear of losing ownership and the other is high cost of transferring immovable property. “ When you transfer an asset, say a house, to a Trust, you technically stop being its owner. It is now held for the benefit of somebody else, say, your wife and children. This is the main reason people hesitate,” says Thomas. By appointing himself a trustee, aperson can still control the asset, but he stops being its owner. Another reason for not setting up atrust is costs. When immovable property is transferred into a trust, stamp duty has to be paid, which could range from five to 15 per cent ( depending on the state).

Choose the right trust structure:To beat the loss of ownership problem, create a revocable trust. This allows you to retain the right to shut down the Trust and take back your assets. In an irrevocable trust, the owner cedes this power entirely. “ People set up a revocable trust when they feel the need to retain control and are not yet ready to pass on control to trustees. Often they may wind down a revocable trust if they find it difficult to manage,” says Ajinkya. Younger people, or those confident that they will not have issues with creditors, opt for this structure.

Some Non- Resident Indians (NRI) could benefit from setting up arevocable trust. “ If the settlor or the beneficiaries have tax residency in the US, setting up a revocable structure offers certain tax benefits,” informs Ajinkya.

The tax treatment of the two types of Trusts is different. In a revocable trust, the income is taxed at the hands of the settlor ( the person who forms and transfers his property into a Trust). In an irrevocable trust, the income is taxed at the hands of the trustees, in their capacity as representatives.

While deciding which structure to opt for, remember that a revocable Trust will not be as effective in offering protection against bankruptcy or in avoiding estate duty.

Choose the right trustee: The trustee has to be someone you can trust. It could be one or several individuals, or a company. A trustee has fiduciary ownership over the trust’s assets. While he should manage the wealth as if it is his own, he should do so for the benefit of the beneficiaries, and abide by the provisions of the Trust deed. The Indian Trust Act lays down many guidelines for trustees. If they don’t discharge their duties properly, they can be held liable for breach of trust.

Many HNIs nowadays choose corporates to act as trustees. If the Trust is to continue for generations, they want perpetuity of the entity that is acting as the trustee. If the corporate is a reputed entity, there could be lower probability of mismanagement. Many HNIs also choose friends or family members as trustees, so that they can exercise better control over the functioning of the Trust.

Business Standard New Delhi,08th August 2016