[Opinion] Private Discretionary Trusts and the Surcharge Conundrum

Subham Agarwal – [2026] 185 taxmann.com 778 (Article)

Typically, trusts are created to manage wealth, protect assets from creditors, and ensure smooth succession planning for intended beneficiaries. Trust is a legally secure framework for managing family property, providing for dependents, maintaining confidentiality, and achieving tax efficiency.

1. Meaning of a Trust

A trust is a legal agreement whereby one person, known as the settlor (also known as the author or creator of the trust), transfers ownership of property or assets to another person known as the Trustee, in order to manage and hold for the benefit of a third person or group of people known as Beneficiaries.

The concept of private trusts in India is governed by the Indian Trusts Act, 1882, while the taxation is governed by the Income Tax Act, 1961 (Income Tax Act, 2025).

Three important constituents of a Private Trust are as follows:

(a) Settlor (Author or Creator of the Trust) – The person who creates the trust by transferring property to the Trustee. The settlor defines the terms & conditions and objective of the trust through a Trust Deed or through a Will (known as a Testamentary Trust).

(b) Trustee – The Person or entity to whom the property or assets are vested and who holds the legal title of the trust property. A trustee is bound by fiduciary obligations to manage the trust property in accordance with the trust deed and for the benefit of the beneficiaries. Under the Income Tax Act, the trustee is treated as a Representative Assessee under Section 303(1)(d) of the Income Tax Act, 2025 [corresponding to Section 160(1)(iv) of the Income Tax Act, 1961].

(c) Beneficiaries – Person or group of people for whose benefit the trust property is held and managed. They hold the equitable or beneficial interest in the trust property. Their entitlements may be fixed and determinate, or they may be left to the discretion of the Trustee, as mentioned in the Trust Deed.

2. Types of Private Trust

Private trusts are created for the benefit of identifiable individuals or a defined group of people. They broadly fall into 2 categories, namely:

(a) Specific Trust (also known as Determinate Trust) – Where the beneficiaries are clearly identified, and their respective shares in the trust income or corpus are determinate or known.The trust deed specifies the proportion of income or capital each beneficiary is entitled to receive. Here, the income is assessed individually in the hands of the beneficiary, in proportion to their respective shares and taxed at the rates applicable to each beneficiary. The taxation of a specific trust is governed by Section 304 of the ITA 2025 [corresponding to Section 161 of ITA 1961], which provides that the representative assessee (trustee) shall be assessed in like manner and to the same extent as the beneficiary.

(b) Discretionary Trust (also known as Indeterminate Trust) – Where the Trustee holds the power to decide the group of beneficiaries who can receive either capital or income from the trust, entirely at the trustee’s discretion. In other words, the distribution of all capital and income is completely at the discretion of the Trustee. In these kinds of trusts, not only are the beneficiaries’ identities unknown or indeterminate, but the beneficiaries’ shares are as well. This stand has been accepted and followed by several judicial precedents.

3. Taxability of Private Discretionary Trusts at the Maximum Marginal Rate

The taxation of Private Discretionary Trusts is governed by Section 307 of the ITA 2025 [corresponding to Section 164 of the ITA 1961].

Section 164(1) of the repealed ITA 1961 states that:

“Subject to the provisions of sub-sections (2) and (3), where any income in respect of which the persons mentioned in clauses (iii) and (iv) of sub-section (1) of section 160 are liable as representative assessees or any part thereof is not specifically receivable on behalf or for the benefit of any one person or where the individual shares of the persons on whose behalf or for whose benefit such income or such part thereof is receivable are indeterminate or unknown, tax shall be charged on the relevant income or part of relevant income at the maximum marginal rate.

Provided that in a case where—

(i) none of the beneficiaries has any other income chargeable under this Act exceeding the maximum amount not chargeable to tax in the case of an association of persons or is a beneficiary under any other trust; or

(ii) ….

(iii) …..

(iv) …..

tax shall be charged on the relevant income or part of relevant income as if it were the total income of an association of persons.”

Further, in relation to clause (i) of Section 164(1) of the ITA 1961, the CBDT vide Circular No. 281, dated 22-09-1980, clarified that for a trust to be covered in the first proviso, both conditions stipulated under clause (i) of the proviso must be cumulatively satisfied. The relevant extract of the circular is reproduced below:

30.3….

2. …. With a view to ensuring that the provision is not misused in this manner, the Finance Act has amended the relevant provision to provide that a discretionary trust would be liable to tax at the maximum marginal rate unless none of the beneficiaries had any other income chargeable to tax nor is he a beneficiary under any other private trust. It has also been clarified that, in this context, income chargeable to tax would mean total income above the exemption limit for the relevant year. As a result, the income of a discretionary trust will be chargeable to tax at the maximum marginal rate in cases where any of the beneficiaries has any other taxable income exceeding the exemption limit or if any of the beneficiaries is a beneficiary under any other private trust.

In essence, trusts created for the benefit of individuals will typically be taxed at the maximum marginal rate where income earned by that individual exceeds the basic exemption limit.