Wealth planning: all-change India

  • Author : Bijal Ajinkya
  • Date : December 2012
ABOUT THE AUTHOR: Bijal Ajinkya is a partner at Nishith Desai Associates in Mumbai

Estate planning as a topic is still very nascent for a large chunk of the Indian population. Lack of estate duties and gift taxes is mainly responsible for this.

Most Indian residents still believe that drawing up a will for transmitting the assets to their heirs is probably the only means to the end. It is cheap and effective and also serves the Indian attitude of maintaining control of the assets till the date of their demise.

Also, the existence of the Hindu Undivided Family System, whereby the business is held by the family as a whole and each member born into the family gains undivided ownership of the family business and assets, also dispensed with the need for succession planning.

However, the view among most of the high-net-worth families (which still form a single-digit part of the entire population) and the upper-middle-class population, seems to have been changing since 2008, the year of economic meltdown. Asset protection became the order of the day and all efforts were devoted towards securing the assets for the family and the coming generations against various personal guarantees and exposures from investments in the stock markets.

The introduction of community property law and the discussion about reintroduction of estate duty has also served as a push in this direction. As a background, the government has amended marriage laws to include community property provisions, whereby a divorcing spouse will have a right to all post-marital property to the tune of 50 per cent, which shall override succession laws and divorce settlements. The government has also amended divorce laws by eliminating the ‘mandatory separation period’ prior to divorce. Separately, the discussion on revival of inheritance tax has resumed in the Parliament as well.

Further, the issues are no longer restricted to succession of assets but also to succession of the family business. The Indian private client also became more self-aware in terms of realising the needs of different members of the family and the need to plan differently for each one of them.

“For some Indian private clients, estate planning is no longer limited to drafting a will”

Additionally, there has been a move of late to diversify asset holdings rather than have them under one umbrella structure. With the choice of various wealth products being made available by wealth managers, Indian private clients have become increasingly educated in managing their wealth effectively and planning for the future. With the liberalisation of exchange-control regulations, a lot of Indian clients have also been investing in and acquiring foreign assets and have shown interest in acquiring succession products such as insurance, and so on.

It has thus become very evident to high-net-worth Indian families that the straightforward use of wills for all succession purposes is no longer viable. Use of family holding vehicles that provide clear demarcation of business and their succession with various members of the family, whether active in the business or not, are being structured to ensure smooth functioning while attending to family needs. Of these, private limited companies, limited liability partnerships and the Hindu Undivided Family System are still preferred. The trust as a vehicle to conduct business and manage succession is also becoming a preferred choice, since it dispenses with probate or any potential litigation that may arise out of such will. India, being a common-law country, does not recognise foundations. Purpose trusts can also only be used for charitable or religious purposes and not for the purpose of holding businesses for a private family.

All in all, for some Indian private clients, estate planning, per se, is no longer limited to the drafting of a will but has extended to accumulation, management and disposal of an estate as per the desires of the estate owner, and involves financial, tax, medical and business planning. Most clients use trusts in India and abroad for acquiring, holding and managing such assets and planning succession through them.

Trusts

Traditionally in India, a trust was just used to consolidate the assets and ensure that succession happened without having to go through the time-consuming and cost-intensive (and sometimes litigious) probate process.

Today, apart from asset protection, other objectives for setting up a trust are safeguarding the interests of family members, especially those with special needs, attaching conditions to gifts, contribution to religious and charitable causes, avoiding family disputes over the property and achieving tax efficiency.

The choice of the type of trust for Indian clients depends on the objectives that the settlor wants to achieve. For example, an irrevocable discretionary trust is a choice for asset protection; a revocable trust is used when the settlor does not want to give up control on the asset settled or if you have US persons as beneficiaries; and a determinate trust is set up mostly when beneficiaries are residing in high-tax countries that also have a tax treaty with India, etc. Sometimes the choice of a trust structure is also influenced by the regulations that govern the asset class being settled into a trust, e.g. Indian listed-company shares are transferred into a revocable trust whereby the settlor is also made a co-trustee since any transfer (change in ownership or control) to a third-party unrelated trustee may trigger an open offer requirement requiring the trustee to acquire 20 per cent or more shares of the general public holding such company shares.

Indian trusts, however, cannot make foreign investments or asset acquisitions. The Indian exchange-control regulations allow Indian resident individuals to make foreign investments and acquire foreign assets either directly or through special-purpose vehicles such as personal holding companies or trusts. Foreign trusts have been the preferred choice of most clients for such investments for the reasons mentioned above.

An Indian resident having only Indian assets can remit funds1 from India to settle an offshore trust. However, any settlement/ transfer of his non-cash Indian assets (which again is restricted to certain asset classes only) into such an offshore trust, being a capital account transaction, will require prior approval from the regulatory authority; that is to say, a non-resident trustee (not being a non-resident Indian) is not permitted to own immovable property in India. With respect to shares, restrictions may range from the quantum of equity being transferred in a listed company, which may trigger off the provisions of the Indian takeover code2 to sectoral caps as prescribed under the exchange control regulations,3 which limit the extent of holding that a foreign transferee holds in an Indian company.

Tax

Income tax in India is governed by the provisions of the Income Tax Act 1961, which lays down provisions with respect to chargeability to tax, determination of residency, computation of income, transfer pricing, etc. Residents are ordinarily subjected to tax in India on their worldwide income, whereas non-residents are taxed only on their Indian source income, i.e. income that accrues or arises to them in India. While the criterion for the taxation of individuals is based on the number of days of residence in India, for companies it is dependent on the place of control and management in India. For foreign trusts, even a fraction of control and management in India would result in the foreign trust being subject to tax in India.

Conclusion

With the increase in the number of trustee companies and family offices, it is evident that the Indian private client is evolving and becoming more savvy in planning their wealth and succession affairs.

Liberalised Remittance Scheme under which an Indian resident can remit up to USD200,000 for any permitted current or capital account transactions or both.
Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997.
FEMA (Transfer or issue of any security by a person resident outside India) Regulations, 2000.

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