Indeterminate Trust
Also written Discretionary trust
A trust whose beneficiaries and their beneficial interests cannot be ascertained from the trust deed. For an AIF, the trustee is taxed on the whole income at the maximum marginal rate under Section 164.
In plain language
Most Indian AIFs are set up as trusts, and for tax purposes one question about the trust deed matters more than almost any other: can you tell, from the deed, exactly who the beneficiaries are and what share each owns?
If you can, the trust is determinate. If you cannot, it is an indeterminate trust. The workbook defines it as "a Trust wherein the trust beneficiaries, and their respective beneficial interests, are not ascertainable as per the terms of the 'Indenture of Trust' or the 'Trust Deed'".
The consequence is severe. Because the beneficiaries are not known, income cannot be taxed in their hands at their own rates. Instead, the trustee pays tax on the fund's income at the maximum marginal rate (MMR). Chapter 4 puts it plainly: an indeterminate trust "is treated as an 'association of persons' and tax is charged on the entire income of the trust at the maximum marginal rate".
How it works
Discretionary and non-discretionary. Indeterminate trusts can be discretionary trusts, where the trustee exercises discretion on using the trust's assets, determines beneficial interests and decides the distribution of income. Non-discretionary trusts are administered as per the clauses of the trust deed rather than the trustee's discretion.
The determinacy test. The Income Tax Appellate Tribunal has clarified, per the workbook, that beneficiaries and their beneficial interests must be capable of being ascertained on the date of the trust deed itself, not left to be decided at a future date by a person other than the settlor. A deed that authorises adding further contributors over time, in addition to the initial contributors, does not by itself make beneficiaries unknown or shares indeterminate.
Taxation.
| Determinate trust | Indeterminate trust | |
|---|---|---|
| Trustee's status | Representative assessee (Section 161) | Representative assessee (Section 164) |
| Business income | MMR, payable by trustee (Section 161(1A)) | MMR |
| Other income (e.g. capital gains) | Assessed as it would be in beneficiaries' hands (Section 161(1)); MMR may not apply | MMR on all income |
| Direct assessment of beneficiaries (Section 166) | Possible if trustee not taxed | Not invoked — beneficiaries are not known |
The workbook gives the MMR as currently 30%. Surcharge and 4% Health and Education Cess apply on top — for AoPs, the surcharge rises to 25% where total income exceeds Rs 2 crore.
Where the status is fixed. The indenture of trust records whether the trust is determinate or indeterminate, which is why investors review it in due diligence.
A worked example
Illustrative figures. Two Category III AIFs, each set up as a trust, earn Rs 10 crore of business income in a year (taxed at MMR in either case). The difference shows up in their other income: each also earns Rs 8 crore of long-term capital gains on listed equity.
Fund D — determinate trust. Its deed identifies every unit holder and their share. The trustee is a representative assessee; the capital gains can be assessed as they would be in the unit holders' hands, so the MMR need not apply to them.
Fund I — indeterminate trust. Its deed lets the trustee decide, at a later date, which investors get what share of income. Beneficiaries and shares are not ascertainable from the deed. Under Section 164 the trustee pays tax on all income at the MMR.
Working the business income for Fund I at the workbook's rates for an AoP with income above Rs 2 crore:
Tax at MMR = 30% x Rs 10 crore = Rs 3.00 crore
Surcharge at 25% = 25% x Rs 3.00 crore = Rs 0.75 crore
Cess at 4% = 4% x (3.00 + 0.75) = Rs 0.15 crore
Total = Rs 3.90 crore (39% effective)
And Fund I's Rs 8 crore of capital gains is also pulled into MMR taxation, instead of being taxed as it would be in each unit holder's hands. A single drafting choice in the trust deed has made the whole fund's income taxable at the top rate.
Why NISM asks about it
Chapter 9 (Taxation) covers determinate versus indeterminate trusts at 9.2.1, with the ITAT clarification and the Sections 161, 164 and 166 treatment, and summarises it in Figure 9.1; its learning objectives list the concepts. Chapter 4 (Category III AIF: Fund Structures and Service Providers) describes the indenture of trust's role in fixing determinacy, and Chapter 7 includes it in investor due diligence. Expect questions on the definition, on MMR taxation under Section 164, and on why adding contributors does not make a trust indeterminate.
Common exam traps
- Indeterminate = beneficiaries and their shares not ascertainable from the trust deed. Determinate = ascertainable at all times during the trust's existence.
- Indeterminate trust income is taxed at MMR in the trustee's hands (Section 164) — the workbook gives MMR as currently 30%, plus surcharge and cess.
- Section 166 (direct assessment of beneficiaries) is not invoked for an indeterminate trust, because the beneficiaries are not known.
- Adding contributors over time does not make a trust indeterminate, if the deed authorises it — the ITAT clarification.
- Discretionary trusts are a type of indeterminate trust; non-discretionary trusts follow the deed.
- Revocability is a separate axis. A revocable transfer taxes the income in the transferor's hands (Section 61), whether or not the trust is determinate.
- Category III AIFs lack Section 115UB pass-through whatever their trust type; that regime covers only Category I and II AIFs.
Where this is taught
- Series XIX-B · Chapter 4: Category III AIF: Fund Structures and Service Providersintroduced here
- Series XIX-A · Chapter 5: Alternative Investment Fund Structuringintroduced here
- Series XIX-C · Chapter 8: Alternative Investment Fund Structuringintroduced here
- Series XIX-E · Chapter 14: Taxationintroduced here
- Series XIX-B · Chapter 9: Taxation
Related terms
- Category III AIFThe AIF category for funds running diverse or complex trading strategies with leverage — hedge funds and their kin — and the only category denied tax pass-through status.
- Determinate trustA trust whose beneficiaries and their beneficial interests are ascertainable from the trust deed throughout its life — the structure that lets a Category III AIF avoid MMR on non-business income.
- Irrevocable trustA trust whose settlor cannot take the property back, which is why the workbook records that it is protected from the settlor's bankruptcy and usable to secure the interests of dependents.
- Maximum Marginal RateThe highest slab rate of income tax, applied to a Category III AIF's business income at fund level because the fund gets no pass-through — 30% before surcharge and cess.
- Representative AssesseeThe capacity in which the trustee of an AIF set up as a trust is assessed to income tax under Sections 161 and 164 — paying on behalf of the beneficiaries so the same income is not taxed twice.
- Revocable trustA trust the settlor can revoke at his discretion or with the beneficiaries' consent. Income from a revocable transfer is taxed as the transferor's, so an AIF set up this way gets no pass-through.
- Revocable transferA transfer to a trust whose document lets the transferor get back the income or asset, or reassume power over it; income from it is taxed in the transferor's hands under sections 97 and 98 of the ITA.
- Distributable Net IncomeThe portion of a trust's income allotted to its beneficiaries and taxed in their hands, computed as taxable income minus capital gains plus tax exemptions.
- Hybrid trustA trust that pays a fixed, pre-decided amount to beneficiaries out of part of the trust property, while the trustee has full discretion over how the remainder is distributed.