PPT on Succession Planning | Taxmann

Succession Planning 04 December 2021

Bijal Ajinkya Privileged & Confidential

Speaker

Bijal Ajinkya

Partner Tax and Private Client, Khaitan & Co : bijal.ajinkya@khaitanco.com

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Introduction to Succession Planning

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Tools to Succession Planning

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Introduction to Trusts as a tool of Succession Planning | Framework and Benefits

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Introduction to Succession Planning Trends, Need, Considerations

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Trends in Succession Planning Focus on foresight and awareness: Strong emphasis on planning succession of business assets and family wealth

1 I do might:

Concept of succession is evolving:

Preparing for breakdown of marriages leading to increased preference for prenup trusts, trusts with restrictions to spousal access

New dawn, new day, new shores: Relinquishment of Indian citizenship, inbound and outbound migration have become a noticeable trend. Singapore always in top #3

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Maintenance of family: Creating a framework to provide for family’s maintenance and medical needs Privileged & Confidential

Planning succession of assets and business to facilitate the contribution of ‘Next Gen’ and enable smooth intergenerational transfer. Wills no longer taboo!

2 Landscape Metamorphosis

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Ring fencing of assets: Businesses come with their own set of risks and liabilities, thus protecting personal wealth from the uncertainties of business is key driver

Preparing for the inevitable: Ready or not, here it comes? Estate Duty 2.0 – Earlier concerns regarding estate duty law, now a reality 4

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Legal Milestones Amendments to Hindu Succession law to include daughter as a coparcener. Family Law consultation paper 2018

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Total transparency: Era of FATCA, CRS, exchange of information (EOI). Schedule FA, ITR (2012) Stricter reporting | Significant beneficial ownership rules + Form A2 for making remittances abroad

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Abolition of Wealth Tax Complete overhaul to insolvency and bankruptcy with the introduction of IBC. Key changes to Mental Healthcare Act, role of guardian for persons with special needs

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SEBI Circular on transfer of promoter holdings to trusts (2017)

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Introduction of requirement for Settlor and beneficiaries to be ‘relatives’ in case of trust structures (S. 56), Change in tax residency rules for individuals (S. 6, S. 6A)

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Key rulings on trusts | trust = individual, rights of beneficiaries in offshore trusts, trust disputes 5

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In the News…

Personal Guarantee lives on  Recent Supreme Court decision - Lenders free to invoke Personal Guarantees of Corporate Debtor under the Insolvency and Bankruptcy Code, 2016  Bringing personal guarantor under the ambit of insolvency process is in furtherance of the objective of the Code  Recognised the proximity of personal guarantor with corporate debtors  Sanction of a resolution plan per se does not operate as a discharge of a personal guarantor’s liability

OECD Report on Inheritance Taxation in OECD Countries Arguments advanced in favour of inheritance tax (relevant for India) 

There is a good case for making greater use of inheritance taxation in OECD countries.

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Enhances equality of opportunity

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Reduce wealth inequality, particularly in the longer run and if revenues are redistributed

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Can help prevent the build-up of dynastic wealth

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Evidence of significant inheritance and gift tax planning

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Double taxation argument appears to be weak

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Why?

Who?

Enabling next gen – passing the baton Business succession Asset protection Estate duty planning Cross-border laws

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How?

When?

One size does not fit all! A combination of succession tools Common to have Wills + Trusts

Now! Time is of essence No prescribed threshold of asset value, age 2 prong approach Interim measures + Final structure

business

families with multiple family branches  Gen 2 / Gen 3 promoters  Entrepreneurs

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Why Plan?

Why Plan?  Plan Ahead: Blueprint for ensuring asset preservation and growth.  Preparing for a rainy day: Ring-fencing business risks and liabilities.  Mitigate tax liability and family disputes: Smooth transfer of power and control of business / wealth to next gen to the other.  Philanthropy: Giving back to the society at large.

Need of the Hour!  Boom in wealth generation: Per Capegemini’s World Wealth Report 2019, India and China had nearly 9% of High Networth Individuals (HNWI) global population and as per the 2021 Report saw a 5.9% increase in HNIs in India during the year 2020.  Preparing for the inevitable: Strong concerns on India re-introducing estate duty law.

 Citizenship and Residence Planning: Relinquishment of Indian citizenship and acquiring foreign citizenship, inbound and outbound migration have become a noticeable trend.  Pre-nuptial agreements? Rising popularity of spousal trusts.  Covid related uncertainties  Tightening the noose around promoters (bankruptcy and insolvency, personal guarantees) Privileged & Confidential

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Roadblocks to Succession Planning

Challenges faced by families  Hesitation to discuss succession planning  Cultural taboo and stigma associated with the topic  Lack of effective communication amongst family members  Lack of correct guidance / advice  Fear of the unknown: Legal implications, financial implications, division and fragmentation of assets

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A Fine Balance!

Global asset base Indian & Offshore Laws

Residency & Citizenship

Wealth creation & Expansion

Business

Family

Estate & Inheritance taxes

Wealth preservation

Philosophy & Values Confidentiality & Reporting

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Examining some curious cases Structuring listed shares using trusts

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December 2017 Circular: Compliance is key: SEBI thresholds, undertakings & filings Segregation of listed and unlisted assets is key Dilemma of ‘control’, Choice of trustee (no PTC, professional trustee allowed) No layering involved (sub-trusts frowned upon) Timelines & costs for prior SEBI application

Planning for creditor claims using trusts

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Stringent rules under new insolvency code; Recent SC ruling Creating trusts that are irrevocable & discretionary 2-year period from date of transfer & restrictive rules to prevent ‘fraudulent transfers’ Retaining some assets in personal file if PGs given Segregating personal and business assets Direct gifts to daughter on marriage

Navigating disputes among family

Planning for strained marital relations Privileged & Confidential

Safeguards of valid will – doctor certificate, videography, disinterested witnesses Lifetime gifts of specific property Trusts with ‘excluded persons’ and stringent terms Family settlement to deal with ancestral property  Partition of HUF with nominal distribution to all & NOCs    

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Pre-nuptial planning using trusts Separate spousal trusts Including grandchildren as direct heirs Naming specific guardians in trusts and wills Spousal restriction clauses in trusts (as trustee and beneficiary) and wills 11

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Tools to Succession Planning

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Tools to Succession Planning| An Overview

Trusts

Wills

Smooth transition of assets without court intervention and flexibility of distributions

Properties pass upon the death of the testator

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Shareholders Agreement

Family Constitution

Family Office

HUF

Where familyowned companies are the subject matter

If the business is managed by various branches of a family; Acts as a guide in managing the business

if the interests of a family are segregated amongst diverse portfolio companies/ management of funds required

Archaic concept; Complexity around determination of interests of coparceners in the properties held by ‘HUF’ – daughters rights a key consideration

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Trust the ‘Trust’

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Image Source: https://theoatmeal.com/comics/trust Privileged & Confidential

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Trusts | Legal Framework

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Private Trusts: Indian Trusts Act, 1882 (Trusts Act)

Charitable Trusts: State specific legislations such as Maharashtra Public Trusts Act, 1950; else Trusts Act

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A “trust” is an obligation annexed to the ownership of property, and arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him, for the benefit of another, or of another and the owner Privileged & Confidential

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Overview of Trusts

Funds / Shares

Settlor Creator / Author / Owner of assets settled into the Trust Contributions may be undertaken in lifetime / through Will Should not assume any other role

Should not have the power to revoke

May provide a LOW to Trustee

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Beneficiaries

TRUST

Generally, an Generally, a Indian resident person of an with foreign older generation sourced funds

One person should be Settlor

Play a passive role & receive economic benefits / distributions

Trustee

Legal owner / manager of property Complete discretion with Trust assets Professional Trustee / PTC

Should be ‘relatives’ of the Settlor Class of persons in Family may be named

No vested interest in Trust property

Endowed with statutory rights

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Can be layered as Primary, Secondary and Tertiary

Eligible to income and / or Trust corpus

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Types of Trusts

Nature of Assets

Trustee Succession

Decision-making

Amendment

Objects Parties

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Dispute Resolution

TRUST

Irrevocable

Revocable

Settlor has no controlling powers on Trust assets

Settlor can control Trust assets and claw it back

Specific

Dissolution

Discretionary

Each beneficiary Each receives Trust assets beneficiary’s at trustee’s share in Trust discretion assets is known

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Benefits of a Trust

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Protection against potential inheritance tax/ estate duty.

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Smooth transition of assets in lifetime.

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Strong governance mechanism can be established.

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Provides financial stability without absolute ownership of assets.

Tool for creditor protection, matrimonial disharmony.

Retaining control indirectly post transfer - plan it right from a tax perspective.

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Benefits of a Trust

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Limited role of court / judicial bodies.

Flexibility to make distributions based on specific needs of beneficiaries.

Appointment of specific individuals as guardians, subject to applicable laws Segregating business and personal assets in separate trust structures.

Providing for distribution of assets on major milestones in beneficiaries’ lives – attainment of certain age, marriage, graduation, etc.

Issuing letter of wishes to the trustees to guide them with respect to management of the trust property, distribution of the trust assets, the life of the trust, etc.

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Taxation of Trusts Taxation of Trusts On Settlement:  

Transferor - no capital gains / income tax Transferee - tax exemption included vide Finance Act 2017, if trust settled for beneficiaries who are ‘relatives’

During the life of the Trust    

No double taxation – taxed @ the trustee or beneficiary level (never both!)

Revocable: tax on income of trust to be paid by settlor Irrevocable: tax to be paid by trustee/ beneficiary depending on whether trust is discretionary, determinate or a business trust Determinate v. discretionary trust taxation

On extinguishment of trust:   .

No tax as capital gains No Income tax in the hands of the beneficiary

Stamp duty implications on settlement & distribution 

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Generally, a nominal settlement amount is initially settled into the trust .

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Image https://www.cartoonstock.com/directory/t/trust_problems.asp

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Offshore Trusts | Key Issues

The right fit? Family office / business owners – Nextgen & established business owners / Fast-growth companies

LRS v. ODI, portfolio & passive investments, opening foreign bank account

RELOCATION PLANNING FOR INDIVIDUALS

Source of funds (foreign sourced or Indian), parties to a trust, control on trust investments

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TAX REPORTING & DISCLOSURES

REMITTANCES & INVESTMENTS

CREATING AN OFFSORE TRUST

FATCA, CRS, Schedule FA of Indian tax return

RETURNING HNIS

OFFSHORE FUND MANAGEMENT

Sweet spot | Planning an offshore trust prior to return – dos & don’t’s

Indian tax considerations such as POEM, PE

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Offshore Trusts | Key Considerations Objectives:

Maintenance, education of family abroad, tax planning

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Structuring Control of the Trust Role Settlor, Protector, Investment Advisor, Significance of Letter of Wishes

Jurisdiction of the Trust:

Key Considerations

Indian Taxation: Taxation of distributions to beneficiaries, Reporting under Schedule FA

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Choice of Administrator: Legal requirement in most offshore jurisdiction. Government licensed trustees / trust administrators Privileged & Confidential

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Jersey, Guernsey, Singapore, New Zealand

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Parties to the Trust- Settlor and Beneficiaries: Tax residence, source of funds, premigration planning, relationship between parties

Assets: Ideal for financial assets, real estate, insurance policies, art

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Wills

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Timing is Everything!

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Image from: https://countrylawyer.net/2020/02/not-just-death-and-taxes-5essential-legal-documents-you-need-for-incapacity-planning/

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Succession Laws in India Modes of Succession In India, succession of an individual’s assets can occur in two modes:

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Intestate (Eg: As per personal laws such Hindu Succession Act, 1956) or

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Through a testamentary instrument (Indian Will)

Intestate Succession 

Depends upon the faith the individual follows –  Indian Succession Act, 1925, Shariat Act, 1932, Hindu Succession Act, 1956.

Eg: On demise of a Hindu male, succession to ‘Class I heirs’ (Eg: son, daughter, widow, mother) shall each receive an equal share.

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In case of the demise of an individual intestate,  succession determined by applicable personal law (Could include forced heirship rules).

There is no flexibility to change this distribution pattern.

Testamentary Succession 

If a valid Will has been prepared by the individual, then it shall govern the distribution of assets to heirs including who inherits what and how much.

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Key Elements of a Will

Testator – individual who prepares the Will

Executor – individual(s) who give effect and implement the Will

Legatee / beneficiaries – individual(s) / heirs who receive the assets

Witness – at least 2 individual(s) who attest to the testator signing the Will and are physically present at the time of the testator signing the Will

Key Roles:

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Pre-requisites to drafting a Will

Identity Assets

Identify Executors

Identify guardians for minor children

Identify Heirs

Identify Witnesses Privileged & Confidential

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Key Features of a Will

Key Features of a Will 

Flexible document, no specific format.

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No stamp duty.

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Confidentiality maintained.

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No legal necessity to register the Will.

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Complete discretion to bequeath assets as per wishes (except in specific cases eg where Islamic law applies).

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Can cover all assets (listed shares, unlisted, moveable, foreign assets).

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Complete control over assets during testator’s lifetime.

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No regulator intervention for preparing a Will although a probate is necessary in limited cases.

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Ability to amend, review and revise the Will annually or upon occurrence of key milestones.

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Will may be signed outside India.

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Where there is a Will…

Things to bear in mind 

Advisable to have separate Wills for Indian and offshore assets

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Even if it is subject to estate duty (if at all), Individuals should own some assets in their individual capacity

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After every major life event (marriage, birth in the family, demise, etc), a Will should be revisited

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Testamentary trusts for incapacitated or minor legatees can be created under a Will

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Clearly describe assets being bequeathed under Will

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If close family members left out of Will, clearly specify reasons

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It is beneficial if certain assets are bequeathed through a Will –

Immoveable property (onerous transfer costs)

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Wildlife: Possession of ivory items, wildlife trophies is governed by the Wildlife Protection Act , 1972 and requires ownership certificate in the prescribed form. No person other than the person having the certificate of ownership shall acquire, receive, control or possess such articles except by way of inheritance

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Antiques

Carefully name Executors (trusted, preferably younger persons) and provide for succession

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Execution, Storage and Probate of Wills  

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Execution and Storage

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Signed in the presence of two witnesses who must also attest the Will

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Read out a translation of the Will if not in language of comfort

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Video recording the Will reading and signing process

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Notarise the original and copy

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Store with the executor / trusted advisor / locker used regularly

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Probate is certification from the court obtained by the executor so as to carry out the directions provided under the Will

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Mandatory for Wills executed in some Indian states or if immovable properties are situated in those states / cities (Eg: Mumbai, Chennai, West Bengal)

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Normally takes 6-8 months to get a probate (provided it is not contested)

Probate

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Other Tools to Succession Planning HUF, Family Constitution, Shareholders Agreement

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HUF| Relic of the Past?

 Under Hindu customary law, HUF is a unit of family – joint family being the essence  Partition or dissolution to wind-up is now common

 Fiduciary role of Karta – daughters now eligible  Coparceners – karta, son & daughter, their children*

 Members - spouses

 Governing law – uncodified law & provisions of Hindu Succession Act, 1956 (HSA)  Amendment to Section 6 of HSA was made in 2005 to include daughters as coparceners

 Partition can be partial, complete.

Equal or unequal

 Tax – Separate taxable unit  Partial partition recognised

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 Stamp duties to be evaluated at the time of partition

Hindu Undivided Family

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Family Constitution | Introduction 

A formal document providing an insight into the family, its values, goals and expectations, both on the personal and business fronts

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Sets out the relationship between family members and business, the rules, roles and responsibilities applicable to stakeholders

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Created with the objective of longevity of family unity and family business Living-sharing Together

Business Together

Celebrating Festivals Together

Source: Kavil Ramchandran, The 10 Commandments for Family Business Privileged & Confidential

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Family Constitution | Pros and Cons Pros 

Leads to family members working together and communicating which in turn leads to a better and deeper understanding amongst them.

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A participative and systematic process of open discussions amongst family members and owners.

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Helps in establishing stable ownership rules for the governance models of a family business.

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Helps in charting out a clear succession criteria.

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Helps to record and formalise the devolution of family wealth, vision and values.

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Lays down exit mechanisms for family members.

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Enables an integration of the three dimensions namely- family, business and ownership.

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Helps in reducing disputes amongst family members and provides a systematic process for conflict resolution.

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Cons 

Not enforceable in a court of law.

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Family members may be un-cooperative about meetings and reviews.

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Lacks an effective and systematic implementation and execution mechanism in India.

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Family’s needs and aspirations can override the Family Constitution.

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Shareholders Agreement 

Trustee-shareholder may enter into SHAs akin to an individual.

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Key succession and commercial clauses shall be included in the SHA to prevent economic erosion of business holdings:

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Right of First Offer / Refusal, Exit.

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Professional management / Board of Directors.

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Role of heirs in ownership and management.

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Choice of trustee & SHA

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Concept of ‘Reserved Corpus’

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Intimation & Prior Consents, especially if there is an investor

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Snapshot of a Succession Plan

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Making a Succession Plan

Approach / discussion with family

Collate assets / liabilities

Personal / Succession laws

‘All Is Well’ ?

Periodic review

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Make a Will

Consider a lifetime gift?

Implement the ‘Plan’

Amend / revise the Will (Codicil)

Appoint ‘trusted advisors’

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