Personal Finance - taxation

In India, securitization vehicles have historically been predominantly set-up via a trust structure with the underlying assets being transferred by way of sale to a trust. This has been the case irrespective of the regulatory regime under which such securitization vehicles have ben set-up.

In a typical loan securitization transaction, the lender grants a loan to a borrower backed by an asset. The receivables are transferred by the lender to a SPV, formed as a trust registered under the Indian Trusts Act, 1882.

The trust thereafter typically issues a Pass-Through Certificate (PTC) to the various investors. The investors are normally financial institutions such as banks, mutual funds and NBFCs. Investors holding PTCs are entitled to a beneficial interest in the underlying assets held by the trust as determined and specified in the trust deed. The issuance of PTCs does not imply transfer of property by the SPV but certification of beneficial interest.

Position Prior to 2013: Prior to 2013, the domestic tax law did not contain any specific provisions for taxation of the participants involved in a securitization structure — i.e., the trust and the beneficiaries of the trust. Accordingly, the taxation of the trust and the beneficiaries was governed by the prevailing provisions for taxation of trusts.

Irrevocable Trusts

Revocable Trusts

In the Hands of Trust: According to the provisions dealing with trust taxation, the trustees of the trust are treated as a representative assesses who are subject to the same duties, responsibilities and liabilities as the beneficiaries, and the tax treatment of such people is the same as if the income received by the beneficiaries were the income received by or accruing to the representative assessees beneficially. Accordingly, the trustees may be taxed on the income received by them on behalf of the investors, and such tax is levied on the trustee in the same manner and to the same extent as it would be levied on the investors.

However, if the trust is held to carry on business, it is liable to tax at the maximum marginal rate.

However, where the beneficiaries of a trust are unknown or indeterminate, the income of such a trust is taxable in the hands of the trustee at the maximum marginal rate

Where the trust is treated as a revocable trust, the income arising to the trust is subject to tax in the hands of the person assigning the loan to the trust.

In the hands of investors: Investors receiving income from the trust are ordinarily liable to tax on the income earned in proportion to their investment. Where the trustees are characterized as representative assesses and accordingly taxed, the tax paid by the trustees is deemed to be paid by the investors. In this case, the investors would again not be required to pay tax individually on the same income.

However, the tax authorities contested the above position in case of securitisation trusts and passed assessment orders and consequential demand notices to such trusts and contended that the interest received by them from loans is taxable under the head “profits and gains from business and profession,” at the maximum marginal rate.

This stand taken by the tax authorities caused difficulties for PTC holders, particularly mutual funds, whose income is exempt from tax. This matter is under litigation.