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Opinion | Why a trust works best for family wealth

Livemint |

11 August 2020

A private family trust that is appropriately structured with protocols on governance and risk management can effectively serve as a legal structure for holding investments.

India has witnessed a manifold increase in both the number and the wealth of individuals and business owners (high net-worth individuals). Forbes’ rich list for India of March 2020 names 102 billionaires—individuals or families with a combined wealth of more than $300 billion. The great Indian middle class also has several HNIs and entrepreneurs with burgeoning wealth and valuable business assets.

Research statistics and empirical evidence all suggest that business run by a family seldom lasts for more than three generations, with a survival ratio of only 3% by the third generation. This manifests into the need for a more intense focus that HNIs should devote towards wealth preservation and succession planning. HNIs need to transform the way they hold wealth and make investments and leverage on modern-day ecosystem enablers such as family office while setting up family charters or constitutions along with trusts—all of which is a formalized and often professional an aided mode to manage the complexity in protecting the value of the business and preserving family wealth.

Each family is unique, has special needs and circumstances and clearly there is no straight answer on the legal structure that fits all. A proper analysis of factors such as nature, size of family, the complexity of the assets owned, values and process that drive decision making, goals and aspirations along with distinctive circumstances would help one to arrive at a practical structure.

The investments that HNIs make can be housed either under a company (“corporate"), limited liability partnership (“LLP"), a private trust (“trust") or a Hindu Undivided Family (HUF). Some of the key considerations that would govern the choice are:

Taxation: Currently the headline tax rate for Individuals, HUFs and trusts is 30% (with the effective tax rate between 35-43% due to applicable surcharge and cess), the base tax rate for a company is 22% (translates to effectively 25%, including surcharge and cess). With MAT no longer applicable, there is a clear arbitrage to hold investments (especially income-yielding instruments) in a corporate structure where family members do not have requirements for liquidity in their personal capacities and the funds pooled under the corporate would usually get redeployed. Corporate structure nevertheless involves a duly layer of tax and any distribution from a corporate will trigger an additional tax on dividend. Where the investment portfolio comprises of listed equities or mutual funds aimed at earning capital gains that attract tax at special rates (10-15%), it may be more efficient to hold such instruments under a trust, LLP or even as Individuals or HUFs (based on other considerations as mentioned below).

Succession Planning: Trust is perhaps the most flexible tool to facilitate a seamless transition of wealth across generations. This has been extensively used by successful families globally. Other entity forms have certain inherent limitations, due to stipulations under governing laws, to properly address succession requirements, segregation of economic interests and governance. Trust can also be a shield against any future levy of estate or inheritance tax.

Ring-fencing and asset protection: Business owners in most situations need to provide a personal guarantee for bank loans as certain contracts (business and personal) expose owners to substantial liabilities in a personal capacity. All of this can result in family wealth and personal assets being at risk against claims and disputes. While segregating personal and business assets is important by holding them in separate legal structures, trust usually achieves the ring-fencing more effectively for asset protection against claims.

Secure interest of passive family members: As beneficiaries to a trust, visibility on economic ownership becomes transparent to family constituents who may not have any active intervention in the operating business. In absence of a trust, such constituents would end up holding a direct stake or interest in company, LLP which can often create hurdles in operating the business.

Regulatory requirements: Any financial activities that are housed in a company need to comply with the RBI requirements on NBFC or CIC (in terms of registration, minimum net-owned funds, concentration norms etc). Further, an LLP is not permitted to be engaged solely in financial activities or have investment objectives. A family trust and HUF do not require any registration or compliance with NBFC regulations.

To conclude, a private family trust that is appropriately structured with protocols on governance and risk management can effectively serve as a legal structure for holding investments. While tax considerations are important, it is the qualitative and intangible aspects such as asset protection and succession planning that should be factored in setting up or transforming existing legal entity structures. A robust structure along with well-articulated policies and protocols on governance will greatly impact the outcome of the risk-taking efforts that HNIs and business families take in creating value and will help them to remain focussed on wealth preservation, as a steward of the next generation.