Understanding tax impact of Indian property transfers to a trust for NRIs

I am an NRI living in Dubai and plan to retire in 1-2 years and move to the UK. I have one son residing in the UK and another in India. I intend to create an Indian trust and transfer my property investments in India into the trust. The properties will be divided equally between them and transferred to them after my passing. Will this have any tax implications in India for my son residing in the UK, my son in India, or me?
—Name withheld on request

An irrevocable settlement of Indian property into a trust is not subject to capital gains tax under the Income Tax Act, 1961 (ITA). The recent Finance Act (No. 2), 2024, has removed this exemption for entities other than individuals and Hindu Undivided Families (HUF). 

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However, this change does not affect irrevocable settlements made by individuals, which continue to be exempt regardless of the settlor’s residential status. Therefore, as a non-resident, you would still benefit from this exemption when you transfer property into an irrevocable trust.

The trust itself will not be taxed on receiving property from the settlor, as it is established for the benefit of your children, who qualify as your 'relatives' under ITA provisions. 

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Any deemed rental income from the properties during the trust’s lifetime will be taxed in the trust’s hands (via the trustee) at the same rates applicable to individual taxpayers, since the trust will be regarded as a specific and determinate trust.

While there are no explicit ITA provisions exempting the eventual distribution of Indian properties to your children from tax, you may rely on judicial precedents to take such a position.

It is important to note that the Indian trust law restricts appointing non-residents or foreign-domiciled individuals as trustees. Additionally, Indian foreign exchange laws do not contain any provisions dealing with trusts, though your proposed succession planning through an Indian trust should be permissible in my view.

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Considering the complexities revolving around creation, administration and dissolution of trusts under various Indian laws and also drafting of the trust deed, it is recommended to seek professional advice in this regard.

—Harshal Bhuta is a partner at chartered accountancy firm P.R. Bhuta & Co.

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