The Tax Tribunal Special Bench Clarifies Trust Taxation at Maximum Marginal Rate

The recent pronouncement by the Mumbai Special Bench of the Income Tax Appellate Tribunal (ITAT) in the case involving an Assessee, a private discretionary trust which had filed its Tax return and paid taxes as per Maximum Marginal Rate (MMR) being as per as per the provisions of Section 164 read with Section 2(29C) of the Income-tax Act, 1961 (ITA). The Tax authorities levied the highest rate of surcharge @ 37% for determining MMR, despite the total income being below the threshold for surcharge applicability (INR 50 lakhs).

The Special Bench averred that at first instance, the tax on the total income of the discretionary trust has to be determined by applying the maximum marginal rate, as applicable and thereafter, the surcharge, if any, has to be computed on such income tax based on the quantum of income. The same was based on the following observations:

• Section 164 and Section 167B of the ITA mandate that the income of discretionary trusts, Associations of Persons (AOPs), or Bodies of Individuals (BOIs), where the shares of beneficiaries are indeterminate, must be taxed at the maximum marginal rate but make no reference to surcharge
• MMR is ascribed a definition under Section 2(29A) of the ITA to mean rate of income-tax (including surcharge on income tax, if any) applicable in relation to the highest slab of income in the case of an individual, association of persons or, as the case may be, body of individuals as specified in the Finance Act of the relevant year.
• MMR is to be determined based on the rate of income-tax provided in Finance Act of the relevant year. The expression ‘including Surcharge on income-tax, if any’, within the bracketed portion of section 2(29C) of the ITA, would indicate surcharge finding place in Paragraph A, Part (I) of First Schedule to the Finance Act-2023(computation mechanism under the heading ‘surcharge on income tax’). The expression ‘if any’ used in section has to be read not de hors but in conjunction with the computation mechanism provided in section 2 of Finance Act.
• The interpretation that, surcharge has to be computed at the highest rate of 37% applicable to the highest income bracket of Rs.5 crores and above, irrespective of the nature or quantum of income, as per the definition of MMR would lead to an absurdity and render other carveouts otiose.
• The legislative intent/object for introduction of surcharge levy to the Finance Act was only to augment the Revenue of the Union for developmental work by asking persons in the highest income bracket to contribute little more than the other citizens, for nation building.

The ruling provides welcome relief and much-needed clarity for tax planning and compliance for a specific class of taxpayers (especially private discretionary trusts) by confirming that while the basic income tax for these trusts is indeed at the highest marginal rate, the surcharge component is not automatically applied at its highest rate but is to be levied based on the trust’s actual total income and the progressive slabs specified for surcharge.