Family trust ringfences assets from creditors

India's wealthy have taken a liking towards setting up private trust as a tool for succession planning. Fears of re-introduction of inheritance tax and a need to ring-fence assets to navigate around bankruptcy laws are the most cited reasons for the current trend.

Like a will, a private trust is also an extremely effective tool for estate and succession planning. However, in a will, a need for a probate - a certificate from the courts validating the will – is tedious and expensive. It exposes the privacy of the family.

According to Amit Pathak, managing director, Warmond Trustees & Executors Private Limited, a will is susceptible to challenge (in courts) because it only gains legal sanctity on the demise of the individual. "A trust continues during the individual's lifetime and thereafter. So, to challenge a trust by any beneficiary or by an outsider - it is very difficult a challenge," he said.

Trust

Unlike in a will, the assets of an individual are not directly transferred to beneficiaries, but instead are parked in a vehicle called as a trust. The trust is managed by trustees ensuring that intentions of the person settling the trust are taken care of. The objective for creating a trust is clearly enumerated in an agreement called trust deed.

Importantly, a private family trust can be established while a person is still alive. The objectives for creating a trust may include: to provide for financial needs of loved ones on untimely death or physical incapacity, taking care of a special child after your death, consolidation and a smooth succession of assets or ring-fencing assets against business risk and financial obligations.

The person forming the trust can also impose conditions. "People like to create a private trust, define the end usage and also talk about the time duration at which the individuals in the family should be receiving the assets," explained Pathak. For instance, a trust can be formed to protect assets from getting eroded as alimony on divorce. Many create a life-trust for their children to protect them from a failed marriage.

Pathak said that there have been conditions in the trust deed where parents want their kids to enjoy the assets not when they attain 'majority but maturity', which will be anytime upwards of 25 years or so and not 18 years. Through a trust, one can make a gift to the beneficiary by putting an age-related stipulation. A parent can also insert restriction clauses in a trust for spendthrifts or a drug addict family member.

How to make a trust

A private trust is an entity created under the Indian Trusts Act, 1882. The first step in forming a private trust is to identify assets to be parked with the trust and the persons who will be associated with the trust.

The person setting the trust is called the settlor, the person managing the trust is called a trustee and person for whom the trustee manages the trust assets is called a beneficiary.

"A trustee can be a family member or a friend. Caution has to be taken that one person is not all the three parties at the same time. This can invalidate the trust," said Hardik Shah, an independent lawyer who also teaches family law in Mumbai.

The trust deed has to be dated and signed by a settlor and trustee. A trust deed can put down in writing duties and responsibilities of the trustee, along with the manner in which assets are to be distributed to different beneficiaries.

Some families form multiple trusts for different purposes. A trust can hold all those assets that an individual can hold. If the assets involve immovable property, then registration is a must with the appropriate authority.

The structure

Depending on the objective of forming a trust, it is vital to get the structure of the trust right. Trusts can be revocable or irrevocable. In a revocable trust, the settlor has the liberty to recall the assets parked in the trust at any point in time.

In an irrevocable trust, assets once bequeathed to the trust cannot be called back by the settlor. Trust can also be discretionary where the trustees have the discretion to decide the share of the beneficiary in the trust asset or non-discretionary trust where the share of the beneficiary is spelled out in the trust deed.

"It is important to get the structure right. If the purpose of the trust is to ring-fence assets from creditors, then an irrevocable trust is the requisite structure" said Shah.

It is also important to get the structure right for tax purposes. Depending on the structure adopted, tax on the income from trust property may be levied in the hands of the settlor or the trustee or the beneficiary, Shah added.

Experts said that in an irrevocable trust, as the property belongs to the trust and not the settlor, creditors cannot lay claim on the asset.

"An irrevocable trust is like an insurance policy. It is to ring-fence the promoter's assets against genuine business risk, but not to defraud," said Sandeep Nerlekar, Managing Director and Chief Executive Officer, Terentia, a Mumbai based estate planning firm.

He added that the demand for settling such trusts have increased in the recent past, but existing individuals in muddle with banks will not be eligible to take shelter as law is clear that the trust should be at least two years old.

Time and suitability

Experts recommend trust as a tool for succession planning if a person is a business owner with multiple heirs or if assets are spread across various geographies or if beneficiaries are put outside India.

"Any family with multiple assets, beneficiaries spread across the globe, with certain dynamics and situations in the family; it does make sense to make a private trust. It is a more advanced and effective tool of doing succession planning," said Pathak.

Family disputes around inheritance are often ugly. They end up in a long-drawn-out litigation process leaving permanent acrimony among the family members. And what is worse, is if the person of your choice of bequeaths is unable to enjoy the assets as desired. That is why a timely formation of a succession plan, like setting up a trust in one's lifetime, is vital.

How a private trust works:

• A private trust can be set up while the individual is alive and continues after his lifetime
• It is difficult for an outsider or beneficiaries to challenge a trust
• Assets are placed in the trust and not directly passed on to beneficiaries
• The individual can specify the end usage of assets and the time during when beneficiaries can receive proceeds from the asset