Private Discretionary Trusts and the Surcharge Conundrum

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.

4.     Maximum marginal rate and surcharge- definitions and provisions

Maximum Marginal Rate is defined under Section 2(29C) of the ITA 1961 as the rate of income tax (including surcharge, if any) applicable in relation to the highest slab of income in case of an individual, AOP, BOI, as specified in the Finance Act of the relevant year. It is important to note that income chargeable at special rates (Sections 111A, 112, and 112A of the ITA 1961) remains unaffected by the maximum marginal rate, as such income continues to be taxed at its own specially prescribed rates.

The highest slab rate under the Finance Act is 30%. The words “if any” are of paramount importance. They indicate that the surcharge is not an automatic or invariable component of the maximum marginal rate but is conditional, and can be included if applicable under the Finance Act. This definition does not prescribe the surcharge rate; rather, it refers to the computation method provided under Paragraph A, Part I of the First Schedule of the relevant Finance Act. Extract of Section 2(29C) of the Income Tax Act, 1961, is reproduced below:

“maximum marginal rate" means the 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”

Surcharge is an additional tax levied on the amount of the income tax, i.e., tax on tax imposed for the purposes of the Union under Article 271 of the Indian Constitution. Its levy must be authorised by the Finance Act of the relevant year. The Finance Act prescribes a slab surcharge structure for individuals, HUFs, AOPs and BOIs based on their total income.

Additionally, when the total income includes dividend income or income under Sections 111A, 112 and 112A, i.e., capital gains, the surcharge on tax computed on that part of income shall not exceed 15%. The revenue’s interpretation of “if any” means that the surcharge applies when the Finance Act provides for it, and when it does, it must be the highest rate of 37%. This interpretation has been rejected by the Special Bench in the case of Araadhya Jain Trust vs. Income-tax Officer [2025] 173 taxmann.com 343 (Mumbai - Trib.) (SB), which held that the words “if any” must be read in conjunction with the slab computation mechanism in the Finance Act and not beyond it.

The rate of surcharge in the alternate tax regime for individuals as specified under Section 115BAC, has been capped at 25% if the income exceeds INR 2 crores, i.e., the 37% slab rate on income exceeding INR 5 crores has been removed.

5.     Surcharge must be levied based on the income level

Under the old tax regime, the question of whether a surcharge on private discretionary trusts should be levied at a flat rate of 37% irrespective of income level, or at slab-based rates prescribed in the Finance Act, depending on the actual income, has been the subject of extensive litigation. In relation to the Old Tax Regime, numerous judicial opinions have firmly established that the surcharge must be computed with reference to the slab rates prescribed in the Finance Act, based on the actual income of the trust, and not the maximum rate of 37%.

The rationale is straightforward. The Finance Act prescribes a slabbed surcharge structure with different rates for different levels of income. If the revenue’s interpretation that surcharge must always be levied at the maximum rate of 37% for private discretionary trust were accepted, then the entire slab structure of the surcharge under the Finance Act becomes nugatory and meaningless.

6.     Landmark case laws

Aaradhya Jain Trust v. ITO [2025] 173 taxmann.com 343 / [2025] 212 ITD 1 (Mumbai - Trib.) (SB)

In this case, the assessee is a Private Discretionary Trust with an income of merely INR 4,85,290 for AY 2023-24, and the CPC levied the maximum surcharge rate of 37%, which was upheld by the CIT(A). This issue has created strong conflicting views- several coordinate benches ruled in favour of the assessee, while the ITAT Mumbai bench in the assessee’s own case for AY 2022-23, order dated October 7, 2024, ruled against, holding that surcharge must be levied at the maximum slab rate irrespective of the income level. This conflict led to the constitution of a Special Bench under Section 255(3) of the Income Tax Act, 1961, on November 14, 2024. The Special Bench overturned the earlier position of the Tribunal, holding that surcharge should be computed as per the slab rate prescribed in the Finance Act of the relevant year and not a flat rate of 37%, as accepting the Revenue’s interpretation, it would render the entire slab structure of surcharge and the 15% cap on dividend, capital gains income (under Section 111A, 112 and 112A) nugatory and absurd. The words “if any” in Section 2(29C) must be read in conjunction with the computation mechanism of the Finance Act, and not beyond the scope. The case was decided in favour of the assessee.

The Special Bench ruling has been consistently followed by multiple Tribunal benches across the country, wherein it was held that the words “if any” have to be read in conjunction with the computation mechanism of the Finance Act, i.e., surcharge should be levied at the slab rate and not at a flat rate of 37%. List of judgements that followed the Special Bench ruling are as follows:

(a)  Anmol Trust vs. ITO [2025] 174 taxmann.com 193 (Pune - Trib.)

(b)  GJ Trust v. ITO [2025] 174 taxmann.com 902 (Mumbai - Trib.)

(c)   Rose Trust v. DCIT [2025] 180 taxmann.com 110 (Delhi - Trib.)

(d)  Lintas Employees Recreation Trust v. ITO [2025] 174 taxmann.com 694 (Mumbai - Trib.)

(e)  Sow Rachna Rathi Family Trust v. DDIT [2025] 174 taxmann.com 854 (Pune - Trib.)

(f)   Niruben Ashokbhai Mehta Family Trust v. ITO [2025] 180 taxmann.com 817 (Ahmedabad - Trib.)

(g)  Chanda Bharech Beneficiary Trust v. ITO [2026] 184 taxmann.com 255 (Kolkata - Trib.)

7.     CPC's Systematic Overreach on Surcharge

Despite the strong judicial backing, lead by the Special Bench decision in Araadhya Jain Trust case (supra) and followed by multiple tribunal benches across India, the Centralised Processing Centre (CPC), Bengaluru continues to systematically levy erroneous surcharge at the maximum rate of 37% on private discretionary trust, irrespective of the actual income level. These discrepancies appear to be due to the application of incorrect surcharge rates by the CPC, which are not in line with the provisions of the Finance Act and the applicable tax laws.

The CPC’s algorithm appears to treat the maximum marginal rate as a single composite rate of 42.744% (30% tax + 37% surcharge + 4% health and education cess), applying it uniformly without any reference to the income-based surcharge slabs as prescribed in the Finance Act.

It is crucial that the CBDT issues appropriate instructions to the CPC to rectify its processing algorithms and align them with the law as interpreted by the Special Bench and consistently followed by multiple tribunal benches. Until such correction is made, trustees and their tax advisors must remain vigilant, file rectification requests under Section 154 of the Act, and pursue appellate remedies to secure the relief that the law clearly entitles them to.

8.     Position under the Income Tax Act, 2025

While the judicial position under the ITA 1961 is currently in favour of the assessee by the Special Bench and has been consistently followed thereafter, the legislature has made several important changes in the ITA 2025 intended to fundamentally change the outlook on the applicability of surcharge on private discretionary trust.

The most critical change pertains to the definition of the Maximum Marginal Rate, which has been redefined under Section 2(70) of the ITA 2025. Under the erstwhile Section 2(29C) of the ITA 1961, the words “if any” were the cornerstone of the judicial reasoning in the Special Bench Case of Araadhya Jain Trust and all subsequent judicial decisions, wherein they had established that the surcharge was conditional and had to be levied at the slab rates as prescribed in the Finance Act of the relevant year. However, in the new definition under Section 2(70), the words “if any” have been removed. This omission is not merely cosmetic. It is a deliberate legislative intervention that makes surcharge an automatic and mandatory component of the maximum marginal rate, irrespective of the income level of the private discretionary trust. Extract of Section 2(70) of the ITA 2025, is reproduced below:

“maximum marginal rate” means the rate of income-tax (including surcharge on income-tax) applicable in relation to the highest slab of income for an individual, association of persons or, as the case may be, body of individuals, as specified in the Finance Act of the relevant year;

The practical implication of this amendment is significant. Going forward, under the ITA 2025, a surcharge will be levied at the maximum rate on all private discretionary trusts irrespective of the income level. The entire slab-based surcharge structure, which the Special Bench held must be applied to all discretionary trusts, will no longer serve as a shield against flat-rate levy of the highest rate of surcharge. In essence, the legislature has reversed the judicial position that was established in the Araadhya Jain Trust case by removing the very statutory language upon which the decision was passed.

Furthermore, the corresponding provisions governing the taxability of private discretionary trusts have been re-enacted under the new Act: Section 164 of the ITA 1961 now under Section 307 of the ITA 2025; Section 160(1)(iv) relating to representative assessee corresponds to Section 303(1)(d); and Section 161 governing specific trusts is now Section 304. While the substantive charging provisions remain largely similar, the removal of “if any” from the definition of MMR fundamentally changes the computation mechanism.

The amendment carries a significant irony: what the CPC was doing erroneously under the ITA 1961, levying surcharge at the maximum rate irrespective of the income level of the assessee, will now become a legally correct position under the ITA 2025.  

9.     Conclusion

It is evident that the Araadhya Jain Trust case (supra) firmly established under the ITA 1961, that surcharge on private discretionary trust must be levied at slab rates based on the actual income, and not at a maximum rate, a position consistently upheld by multiple tribunals across India. Despite this clear judicial consensus, the CPC continues to erroneously apply the maximum slab rate irrespective of the income level.

However, the ITA 2025 has fundamentally reversed its judicial position by removing the words “if any” from the definition of the Maximum Marginal Rate under Section 2(70), thereby making the maximum surcharge an automatic and compulsory component, irrespective of the income level, effective from April 1, 2026. This means that what the CPC was doing under the ITA 1961 was legally incorrect; under the ITA 2025 Act, it will now be legally correct.