How revocable trusts work: Decoding its advantages and disadvantages

The term ’trust’ essentially means that the donor divests himself of all the beneficial interest in the property for the benefit of the beneficiaries. A private trust is governed by the Indian Trusts Act, 1882 and could either be structured as revocable or irrevocable. The type of trust you will choose to create for your family will depend on your family’s needs and intentions.

A couple of examples: Mr. A, promoter of a renowned listed company has recently settled his shareholding in a revocable trust, mainly because it serves a two-fold purpose - he is able to retain control over the company shareholding settled into the trust and at the same time the shares will pass on to the intended beneficiaries after his demise.

Mrs. B, a professional, who has substantial assets held in shareholding received through ESOPs, also has settled his assets into a revocable trust. He wants to ensure that his two children and spouse are protected and a scenario in which he is incapacitated is catered to in the most hassle-free manner.

Under a revocable trust, the settlor of the trust, during his lifetime, has the power to revoke the trust funds settled by him and he may also be added as a beneficiary and reap the benefits of his own assets under the trust. A revocable trust offers flexibility to the settlor to have complete control over his assets and at the same time is an effective tool for consolidation of assets.

On the other hand, in an irrevocable trust, once the settlor has settled his assets, he cannot revoke the same. In an irrevocable trust, no control or power is retained in the hands of the settlor and, if structured appropriately, it could ensure that settled assets are ring-fenced or protected.

Let us examine the revocable structure in detail:

The characteristics of a revocable transfer have been envisaged in the Income Tax Act, 1961. In terms of Section 63 of the Income Tax Act, 1961 a transfer shall be deemed to be revocable if-

1. it contains any provision for the retransfer directly or indirectly of the whole or any part of the income or assets to the transferor, or

2. it, in any way, gives the transferor a right to re-assume power directly or indirectly over the whole or any part of the income or assets.

Therefore when the settlor has the power to revoke a trust at his pleasure, or reassume/retransfer any part of the income and/or assets of the trust, such a trust would be a revocable trust. That is the most essential feature of the revocable trust which differentiates it from an irrevocable trust.

In case of a revocable trust, any income of the trust will be subject to income tax in the hands of the settlor. So the settlor is required to include in his return the income of the trust and pay tax on the same.

People create revocable trusts to take care of smooth succession of assets without any disputes, delays or disruptions and to ensure that the interests of their family members are protected. This is done through the trust while retaining control and flexibility.

The main advantages of a revocable trust are as follows -

Flexibility and control -the settlor will retain flexibility and control over the structure. The settlor has the power to add or remove beneficiaries and can even deicide in what proportion the distribution is to be made to the beneficiaries.

Power to be added as a beneficiary -the settlor may add himself as a beneficiary and receive beneficial interest in the trust. This means that distributions can be made to the settlor himself if required.

Smooth transition and transmission of assets - from generation to generation and avoidance of probate for the assets forming part of the trust.It further provides for efficient and disciplined long term management of assets to meet the needs and requirements of the family and to protect their interests.

Future incapacity-the trust can be structured to provide for a scenario where the settlor is incapacitated or could have medical/health problems. In such a situation, a decision making and distribution plan can be pre-decided and included in the trust.

Disadvantages of a revocable trust

No ring-fencing of assets - a revocable structure may not provide protection against financial obligations or estate duty, if it were to be reintroduced in India.

A revocable trust is best used when the aim for trust structuring is to provide for smooth succession in a defined and systematic manner, and protection of assets isn’t a primary concern. This is especially helpful in circumstances where shareholding or certain other assets are intended to be settled into the trust and control, flexibility and the ability to be beneficiary are of utmost importance to your family.

It is important to understand what you wish to gain from the trust, what the intentions of the family are and more importantly what assets are being transferred. This will enable your advisor to recommend whether a revocable trust or an irrevocable trust or a combination of separate trusts of each type that works best for your family.

*The writer is Senior Vice President and Principle Advisor - Estate Planning, Kotak Mahindra Trusteeship Services Ltd.The views expressed in the article are personal.