Discretionary Trust in Your Will: Why It May Escape the Highest Tax Rate
An ITAT ruling holds that a discretionary trust created under a deceased person's Will may not be taxed at the Maximum Marginal Rate under Section 164 of the Income-tax Act, 1961, if it names a defined class of beneficiaries. This matters for business families using Will-based trusts for succession planning.
CA Harun Raaj
Chartered Accountant · Harun Raaj & Associates
Legal basis: Income-tax Act, 1961, Section 164 — Effective: ongoing. Source: https://www.taxscan.in/top-stories/discretionary-trust-created-under-deceaseds-will-not-liable-to-income-tax-at-maximum-marginal-rate-us-164-itat-1428424. Last reviewed by CA Harun Raaj: September 2026.
A discretionary trust created under your Will is a structure your CA or estate planner may recommend for succession planning. The long-standing concern with this structure has been Section 164 of the Income-tax Act, 1961, which taxes discretionary trusts at the Maximum Marginal Rate (MMR) — 42.744% inclusive of surcharge, the highest tax rate applicable in India. A recent ITAT (Income Tax Appellate Tribunal) ruling changes how that concern applies to Will-based trusts.
What Section 164 Actually Says
Section 164(1) provides that where the income of a trust is taxable in the hands of a representative assessee (the trustee), and the shares of the beneficiaries are indeterminate or unknown, the income is chargeable at the Maximum Marginal Rate. The rationale is straightforward: if no individual beneficiary can be identified as the person who should bear the tax, the law charges the highest rate to close the gap.
Section 164(2) carves out registered charitable or religious trusts, which continue to be governed by the beneficial regime under sections 11–13. For private family trusts — the kind business families use for succession — Section 164(1) has created genuine anxiety, because a discretionary trust where the trustee decides who receives what, and how much, in a given year, looks on its face like a trust with "indeterminate shares."
What the ITAT Ruled — And Why It Matters
The Tribunal held that a discretionary trust created under a deceased person's Will (a testamentary trust) is not liable to tax at MMR under Section 164. The reasoning turns on two points:
- A testamentary trust typically names a defined class of beneficiaries — children, grandchildren, or named relatives of the testator. Even where the proportion each beneficiary receives in a given year is left to the trustee's discretion, the class of people who can benefit is fixed and closed.
- Because the ultimate pool of beneficiaries is known, the trust is treated as having determinate beneficiaries for tax purposes and is assessable at AOP (Association of Persons) slab rates, not the flat MMR of 42.744%.
Key point: A discretionary trust created under a Will may be taxed at AOP slab rates instead of the flat 42.744% Maximum Marginal Rate, provided it names a defined and closed class of beneficiaries.
The difference is not academic. Income taxed at slab rates, with the applicable exemption threshold, produces a materially lower tax bill than the same income taxed flat at the highest marginal rate.
The Difference Between Testamentary and Inter Vivos Trusts
Not every trust is treated the same way under Section 164:
This ruling specifically benefits the testamentary structure — a Will-based trust that comes into existence only after the settlor's death.
Common Mistakes Business Families Fall Into
Treating every discretionary trust as automatically MMR-liable. Many families avoid discretionary trusts altogether out of MMR concern. This ruling shows the rule is not absolute — a testamentary structure with a defined beneficiary class may fall outside it.
Not distinguishing testamentary from inter vivos trusts. If a trust is created during your lifetime rather than through your Will, the MMR position is different, and this ruling does not extend to that structure.
Leaving the beneficiary class undefined in the Will. The ruling turns on the trust having a defined class of beneficiaries. A Will drafted to say "such persons as the trustee thinks fit," without naming any class, would not support this reasoning.
Assuming AOP slab rates always mean a lower bill. Even at slab rates, surcharge depends on the trust's income level. The actual saving has to be computed, not assumed.
Points to Discuss with Your CA and Family Lawyer
- Testamentary discretionary trust versus HUF — for families spanning Hindu coparceners along with, say, a daughter-in-law or grandchildren from a second branch, a Will-based trust offers flexibility an HUF does not, since any person can be named a beneficiary regardless of family line.
- Beneficiary class definition — ensure the Will clearly names the class (for example, "my children and their direct descendants") to support the determinate-class position.
- Asset segregation — liquid assets, investment portfolios, and rental property may suit a testamentary trust more naturally than business shares, which carry control implications.
- Coordination with probate — in cities such as Mumbai, Chennai, and Kolkata, a Will must be probated under the Indian Succession Act, 1925, Section 213, and the trust can only operate once probate is obtained. This can add one to three years before the trust becomes functional.
- No clubbing for testamentary trusts — because the settlor is deceased, the settlor-clubbing provisions under Sections 60–61 do not apply, and the income belongs entirely to the trust.
This article provides general information on Indian tax and succession law based on secondary reporting of an ITAT ruling; the primary order has not been independently verified in this piece. Individual circumstances vary, and the structure suited to your family depends on the assets, beneficiaries, and objectives involved.
I'm CA Harun Raaj, Visakhapatnam. If your family is reviewing a Will-based trust or an existing succession structure, reach out to discuss how this ruling applies to your situation.
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See Also
Frequently Asked Questions
Does this ITAT ruling mean I should always use a Will-based trust instead of setting up a trust now?
Not necessarily. An irrevocable inter vivos trust structured with determinate shares — where each beneficiary's proportion is explicitly specified — can also avoid MMR under Section 164 even during the settlor's lifetime. The choice between a testamentary and an inter vivos structure depends on your control preference, family dynamics, and timing, not on this ruling alone.
What is the AOP tax rate applicable to a discretionary trust taxed under this ruling?
A trust falling outside Section 164(1)'s MMR trigger is assessed as an Association of Persons (AOP) at applicable slab rates on its net income, rather than the flat 42.744% Maximum Marginal Rate. The exact slab and surcharge depend on the trust's income level in the relevant assessment year.
If the trust earns dividend income or capital gains, is it taxed the same way as other income?
No. The nature of income carries through to the AOP. Special rates such as those for capital gains on listed shares apply independently of the MMR determination under Section 164; this ruling addresses only whether the flat MMR applies to the trust's income generally, not the rate applicable to specific income heads.
Does this ruling apply once the Income Tax Act, 2025 comes into force for Tax Year 2026-27?
The Income Tax Act, 2025 renumbers provisions but is understood to substantively retain the maximum marginal rate treatment for representative assessees. The reasoning in this ITAT ruling is expected to carry over, but the corresponding section numbers will change, so verify the applicable provision with your CA for filings from Tax Year 2026-27 onward.
What happens if my Will does not clearly name the beneficiaries of the trust?
The ITAT's reasoning depends on the trust having a defined and closed class of beneficiaries under the Will. A Will drafted to leave beneficiary identity entirely open — such as "such persons as the trustee thinks fit" with no named class — would not support the determinate-class argument this ruling relies on.
Does the trust have to go through probate before it can operate?
In cities including Mumbai, Chennai, and Kolkata, a Will must be probated under Section 213 of the Indian Succession Act, 1925, before the testamentary trust it creates can begin operating. This step can take one to three years and should be factored into any succession timeline.
Is my testamentary trust's income clubbed with mine if I set it up in my Will?
No. Because a testamentary trust only comes into existence after the settlor's death, the settlor-clubbing provisions under Sections 60–61 of the Income-tax Act do not apply. The income belongs to the trust itself, distinct from the clubbing risk that applies to a revocable trust created during the settlor's lifetime.
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