The Income Tax Appellate Tribunal, Chennai, has clarified that a private trust receives tax exemption under Section 56(2)(x) of the Income Tax Act only if it is established solely for the benefit of relatives of the settlor. The judgment underscores that hypothetical potential beneficiaries cannot override the actual, documented beneficiaries at the time of asset transfer. This decision provides critical guidance for estate planners and tax practitioners dealing with family trusts.
Background & Facts
The Dispute
The appellant, a private trust established on 1 September 2021 by Mr. Venu Srinivasan, received shares worth ₹15.78 crore as a contribution from the settlor. The trust claimed exemption under Clause (X) of the proviso to Section 56(2)(x), arguing that all beneficiaries were relatives of the settlor as defined in Explanation (e) to Section 56(2)(vii). The Assessing Officer (AO) disallowed the exemption, relying on Clause 5.2 of the original trust deed, which permitted trustees to add entities majority-owned by relatives - potentially including non-relatives as indirect beneficiaries. The National Faceless Appeal Centre (NFAC) and the Commissioner of Income Tax (Appeals) upheld this view.
Procedural History
- 1 September 2021: Trust deed executed with Clause 5.2 allowing addition of entities majority-owned by relatives.
- 3 March 2022: Supplemental deed executed, effective retrospectively from 1 September 2021, deleting Clause 5.2 and replacing it with a provision permitting only removal of beneficiaries.
- 27 February 2024: AO issued show-cause notice proposing addition of ₹15.78 crore under Section 56(2)(x), citing original Clause 5.2.
- 5 August 2025: Ld. CIT(A) upheld the addition, holding the supplemental deed invalid under Clause 8.1.2(b) of the trust deed.
- 16 December 2025: Hearing before ITAT Chennai.
- 28 January 2026: ITAT delivered judgment allowing the appeal.
Relief Sought
The appellant sought deletion of the addition of ₹15.78 crore under Section 56(2)(x) and ₹12 crore relating to erroneous advance tax payment, along with cancellation of interest under Section 234D and penalty proceedings under Section 270A.
The Legal Issue
The central question was whether a trust qualifies for exemption under Clause (X) of the proviso to Section 56(2)(x) when its deed permits removal of beneficiaries but not addition of non-relatives, and whether hypothetical future beneficiaries can negate the exemption based on actual beneficiaries at the time of transfer.
Arguments Presented
For the Petitioner
The appellant’s counsel argued that the supplemental deed of 3 March 2022, effective from inception, had validly replaced Clause 5.2 with a provision allowing only removal of beneficiaries, thereby eliminating any possibility of non-relatives benefiting. He contended that Section 56(2)(x) requires assessment based on actual beneficiaries during the relevant year, not speculative future ones. He relied on CIT v. Trustees of H.E.H. Nizam’s Family (Remainder Wealth) Trust (108 ITR 555 SC), which affirmed that the object of the trust governs tax treatment. He further argued that Clause 8.1.2(b) of the trust deed did not prohibit amendment to Clause 5.2, as the amendment did not alter the object, transfer power, or re-convey property to the settlor.
For the Respondent
The Revenue contended that the original Clause 5.2, which permitted addition of entities majority-owned by relatives, created a possibility of indirect benefit to non-relatives, thereby disqualifying the trust from exemption. It argued that the supplemental deed was invalid under Clause 8.1.2(b), which barred amendments affecting the power of disposition or changing the objects of the trust. The Revenue maintained that the AO and CIT(A) correctly applied the law by focusing on the trust’s potential for non-exempt beneficiaries, not merely its actual beneficiaries.
The Court's Analysis
The Tribunal conducted a meticulous textual analysis of the trust deed and statutory provisions. It emphasized that Section 56(2)(x) requires the trust to be established solely for the benefit of relatives - not potentially or hypothetically. The court noted that the AO had erroneously relied on a clause (5.2) that had been deleted and replaced before the transfer occurred. The CIT(A)’s invalidation of the supplemental deed was found to be legally unsound.
"The amendment is also found to be in alignment with the objects of the trust as it was intended to reinforce the objects viz., the assessee trust so created is meant for the benefit of the family members of the settler."
The Tribunal held that Clause 8.1.2(b) only prohibited amendments that restored power to the settlor, altered the trust’s objects, or transferred disposition rights. The revised Clause 5.2 merely removed the power to add beneficiaries - it did not restore control to the settlor, nor did it change the trust’s purpose. The court further observed that Clause 8.1.2(d) explicitly empowered trustees to remove beneficiaries, validating the amendment.
The Tribunal also rejected the Revenue’s reliance on hypothetical future beneficiaries, stating that tax liability must be determined based on actual circumstances during the assessment year. No non-relative had ever been added as a beneficiary. The court concluded that the trust met the statutory condition of being established solely for relatives.
Regarding the ₹12 crore advance tax, the Tribunal found the assessee’s explanation credible: the settlor had erroneously paid the tax under the trust’s PAN, and the trust had recorded a corresponding liability, repaid ₹10.11 crore, and reflected the balance as payable. The court held this was a repayable liability, not a gift or receipt without consideration, and therefore Section 56(2)(x) did not apply.
The Verdict
The appellant won. The ITAT held that the trust was established solely for the benefit of relatives, entitling it to exemption under Clause (X) of the proviso to Section 56(2)(x). The additions of ₹15.78 crore and ₹12 crore were deleted. The court also set aside interest under Section 234D and penalty proceedings under Section 270A as consequential to the invalid additions.
What This Means For Similar Cases
Actual Beneficiaries Govern Tax Treatment
- Practitioners must document and maintain records of actual beneficiaries during the assessment year, not hypothetical future ones.
- Tax authorities cannot deny exemption under Section 56(2)(x) based on speculative potential beneficiaries.
- Trust deeds should clearly define beneficiaries and restrict powers to add non-relatives to avoid disputes.
Valid Amendments Are Permissible If Object Is Preserved
- Amendments to trust deeds are valid if they do not restore settlor control, alter trust objects, or transfer disposition rights.
- Clause 8.1.2(b) does not prohibit amendments to beneficiary lists if the core purpose remains unchanged.
- Supplemental deeds with retrospective effect are enforceable if properly executed and consistent with original terms.
Advance Tax Payments Are Not Automatic Income
- Erroneous advance tax payments made by a third party into a trust’s PAN do not constitute income under Section 56(2)(x) if recorded as a liability and repaid.
- Practitioners should maintain clear accounting entries showing repayable liability and evidence of repayment to rebut presumptions of receipt without consideration.
- Claiming refund instead of PAN correction does not, by itself, trigger taxation under Section 56(2)(x).
