Succession planning is a preferred choice for seamless transition of wealth

Strategic ideation both from a ‘family’ and ‘business’ perspective may prove to be the catalyst in achieving objectives and complying with tax requirements

Updated: Jun 22, 2017 09:06:36 AM UTC
Image: Shutterstock

Family businesses are considered the backbone of the Indian economy. In fact, 85 percent of Indian businesses are family businesses – the highest in Asia – and contribute almost 80 percent to the Indian GDP. In spite of this, only 30 percent of family businesses make it to the second generation and 12 percent to the third, while only 3 percent go beyond the third generation.

A recent research also revealed that besides the top-four metro cities, non-metro cities such as Ahmedabad, Pune, Nagpur and Ludhiana, etc contribute 45 percent to the Indian HNI population, which encompasses promoters of large family businesses in India.

Such distinctive results necessitate creation of a wealth plan, with an appropriate governance structure, viable from a fiscal and non-fiscal perspective. It is also a wake-up call for HNIs and promoters to push them into planning for succession well in advance.

At the same time, it is important to note that succession planning today is a continuous and proactive process, rather than a reactive one. This should translate into vision-building, better teamwork, and effective performance, both for the successor and the business.

Planning succession: Key ingredients Setting up trusts is gradually gaining importance, as historical concepts of wills, etc, necessitate giving up ownership and control, and is a tedious process. More so, India currently imposes no inheritance tax (likely to come up again as per media reports).

As businesses grow, funding is arranged through myriad sources, navigating the family tree, eventually culminating into a complex web of entities, controlled by multiple individuals. Any planning would require disentangling the ‘crystal maze’ to unlock the value from the business. An effective plan involves identification of key objectives – including segregation of asset ownership and control, ring-fencing personal assets, avoiding disputes, ease of income distribution, tax, regulatory, and fiscal efficiency.

Tax implications of setting up a trust
The Indian Trusts Act 1882 defines private trust as a legal obligation annexed to trust property, arising out of confidence placed in the trustee, for the benefit of beneficiaries, who only have a beneficial interest in property. Such trust may be set up during one’s lifetime, as revocable or irrevocable; and these may be further categorised as:

►    Discretionary: The composition of beneficiaries and their share is unknown (at discretion of the trustees to choose, who and to what extent); or
►    Specific / fixed and determinate: The entitlement of beneficiaries is fixed; trustees having no discretion in determining the share / composition of beneficiaries.

Although, the taxing provisions are complex and cover a gamut of scenarios, a conceptual understanding is as mentioned.

A trust is generally considered as pass through, depending on the residential status. Generally, the trustee is responsible for all tax compliance and acts as a representative assesse; however, the beneficiaries are ultimately responsible to bear the tax burden.

Taxability on settlement
Settlement is likely to be exempt for the settlor. Indian tax law envisages taxability for the recipient on gift; there may be tax implications for the trust or beneficiary, as the case maybe.

Taxability on distribution
Typically, no adverse tax implications may arise. However, this is dependent on facts of the case.

Exchange control regulations
While India allows current account convertibility, full capital account convertibility is not allowed. Various restrictions are imposed on cross-border transactions.

Globalisation, complexity, and recurrent changes in law have led to transitional change in the mindset of HNIs. For instance, the recent change in Indian residency rules made promoters opt for residence outside India to safeguard from POEM regulations. That said, we are also witnessing a reverse-migration of Indian-origin HNIs who are shifting physical presence and consolidating assets in India. The key concern is to preserve family wealth and pass it to future generations. This is gaining higher importance due to global challenges, such as Europe imposing an inheritance tax, US FATCA regulations (under which US officials carry powers to impose punitive levies on undisclosed cash and property that US citizens possess in India).

From the perspective of the regulators, it is vital to understand that not all structures are set up to evade tax but for achieving longer term objectives of succession and wealth management. Therefore, it is imperative that the government continues to provide impetus to create a transparent system of succession planning for the Indian diaspora.

In order to prepare well, albeit there are myriad issues to be addressed in a succession planning exercise, the benefits outweigh the cons and it remains a preferred choice for seamless transition of wealth, if implemented based on sound financial advice. Consequently, strategic planning both from a “family” and “business” perspective may prove to be the catalyst in achieving family objectives. This would require rationalisation of existing structures, and transition from the traditional holding company structures to trusts, in order to gain advantage in terms of tax efficiency, regulatory flexibility, ease of compliance, as well as conceptualisation and implementation of a structure conducive for passing the baton to the next generation.

- By Raghav Malhotra, Senior Professional - EY India

The thoughts and opinions shared here are of the author.

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