Judge ruling: “You are no Mother Teresa and no one goes to Cayman for philanthropic reasons”

Indian court case sees through the sham of discretionary trusts

In a recent ruling from India, a court found that taxpayer Renu Thikamdas Tharani had to pay taxes on several million dollars’ worth held in a bank account in Switzerland. Tharani claimed not to own the account, but to merely be a beneficiary of the discretionary trust (see box) that held the Swiss account through a Cayman company. The bank account was disclosed in the Swissleaks affair (a list of HSBC secret bank accounts leaked by Hervé Falciani). In a judgement worth reading, the bold judges not only quote Shakespeare but give a very blunt description of the reasons why someone would use a tax haven or a bank with a track record of money laundering.

Interestingly, the judges ascertain something we have claimed for a long time: secrecy caused or created by an individual shouldn’t benefit them but count against them. Also, common sense and the principle of reality has to be applied, rather than relying on whatever a taxpayer, an enabler or a tax haven have to say. For instance, when comparing the declared income of the taxpayer to the (undisclosed) amount held in the Swiss bank account, the court in this case concluded it would have taken the taxpayer 11,500 years to earn that much money.

“Discretion” and discretionary trust

A basic trust is a three-way arrangement. A settlor (for example, a rich grandfather) puts assets into a trust which is managed by a trustee (typically a lawyer) on behalf of beneficiaries (for example, the grandchildren.) A discretionary trust is where the trustee has discretion to decide who gets what, when. The beneficiaries can argue that, until they receive a distribution, they aren’t entitled to any of the trust assets, because it’s all up to the trustee. The assets have been given away by the settlor, but nobody is entitled to them yet, so they are in an “ownerless” limbo, ring-fenced from tax, from creditors, or from the rule of law.

“Discretion” is not itself bad: after all, a CEO uses his or her best judgement to manage a company, while a regular trustee manages trust assets on behalf of vulnerable people. The useful function of discretion can be achieved by other means: but no society should tolerate assets being put into this ownerless limbo, above the rule of law.

This Indian ruling deals with many issues we hold dear. First the issue of trusts and especially discretionary trusts, where a settlor puts money into a trust, and the trustee has (on paper) discretion to decide who gets a distribution from the trust money, when, and how much. (We have described the abuses of trusts here and here.) In essence, discretionary trusts should be abolished because they are as abusive as it gets (and there are other, less harmful ways of achieving the discretion function).

They allow individuals to isolate assets from their creditors and from third parties with legitimate claims (such as tax authorities, or the forces of law and order). If abolishment sounds too radical, our proposal is at least to disregard discretionary trusts and the “ownerless limbo” (see box) that they create: if the settlor put assets into a discretionary trust and so far no (discretionary) beneficiary is entitled to them, the assets should be regarded as still being the property of the settlor, for tax and other purposes (eg income, wealth, inheritance) or for any debt owed to creditors. If the law isn’t amended to address this excess, we have to depend on courts, often tax haven courts, to fix the abuses — which may rarely happen.

Before we go into the Tharani case, it is worth mentioning two previous Indian court cases dealing with discretionary trusts and tax abuses. In the first one relating to a Maharaja (ruler), the Supreme Court allowed a discretionary trust to get away with it and not pay taxes. In the next one, involving a Liechtenstein trust, the Indian court put a stop to discretionary trusts’ abuses in the way that we have proposed.

1. The Maharaja of Gonda

The Supreme Court case, Estate of HMM Vikramsinhji of Gondal, refers to a Maharaja who was the former ruler of the Gondal who created two UK discretionary trusts for the benefit of himself, his children, and (c) their wives or widows.  The settlor, who was entitled to the trust income (that is, income coming into the trust) during his life, included this trust income in his income and wealth tax returns. Upon his death, his son also included the trust income in his tax return. However, he then claimed that it was a mistake, both of him and of his dead father, to have included the income to the trust in their tax returns, because the trust was discretionary.

However, even though the trust was labelled discretionary, it’s not that any Indian could have got a distribution. The only potential beneficiaries were family members, including the son. In addition, no one had received income from the trust because in more than five years since the creation of the trust no trustee had been appointed to “exercise discretion” (so even though they may have called it a discretionary trust, it wasn’t a properly functioning one). It appears that had there been no trust, the son would have inherited the assets and would have had to pay taxes on them. So this trust, controlled by people who will benefit from its assets and income, allows those same people to escape taxes on the assets and income merely because they are held in the trust. This makes no sense to us, morally, economically or democratically.

However, the Supreme Court ended up ruling in favour of the taxpayer (the son), despite all these facts showing that this was not a properly functioning trust. The Supreme Court held that the trust was discretionary so the income belonged to the trust, so therefore neither potential beneficiary had to pay any tax:

A discretionary trust is one which gives a beneficiary no right to any part of the income of the trust property, but vests in the trustees a discretionary power to pay him, or apply for his benefit, such part of the income as they think fit. The trustees must exercise their discretion as and when the income becomes available, but if they fail to distribute in due time, the power is not extinguished so that they can distribute later. They have no power to bind themselves for the future. The beneficiary thus has no more than a hope that the discretion will be exercised in his favour.”

Courts do often make nonsensical decisions.  But not always. The next example shows a far more sensible approach.

The Ambrunova Trust from Liechtenstein

This case relates to the Liechtenstein based trust, the Ambrunova Trust and Merlyn Management SA, which had USD 24 million in a bank account. The Indian taxpayer claimed not to be a beneficiary of the trust and thus refused to pay taxes on the income to the trust. However, information obtained based on an exchange of information request revealed that the taxpayer was indeed a beneficiary. This case reveals another reality we have mentioned many times: it’s quite irrelevant whatever the trust document says, whether the trust is revocable or irrevocable, discretionary, or whether someone is mentioned as a beneficiary or not. What matters is how it operates in practice.

As described by a law firm (opposing the ruling):

The revenue submitted factual proof that the Taxpayers were beneficiaries of the Trust, based on trustee records and other records, which were obtained through a Tax Evasion Petition (TEP) filed with Lichtenstein. While the Taxpayers do not appear to have been specifically named in the trust deed itself, the revenue authorities relied upon the beneficiary allocation contained in trustee filings, to add the corpus amounts as the “undisclosed income” of the Taxpayers… Strangely enough, the Tribunal’s ruling has turned on the fact of non-disclosure, rather than the substantive question of whether the income of an offshore discretionary trust should be taxable in the hands of Indian resident beneficiaries.

Interestingly, the Indian court gave a much better decision than what the Supreme Court decided on the Maharaja case. Instead of saying that discretionary beneficiaries are isolated from the assets and income in the trust until a distribution taken place, the court in this case ruled that if a person is the only discretionary beneficiary of a trust, the assets and income held in the trust should be considered to belong to them:

It is a common knowledge that discretionary trusts are created for the benefit of particular persons and those persons need not necessarily control the affairs of the trust. Still the fact remains that they are the sole beneficiaries of the trust. Thus totality of facts clearly indicate that the deposit made in the bank account of the trust represents unaccounted income of the assessee [the taxpayer], as the same was not disclosed by the these assessees in their respective returns in India.

The Tharani case (again)

The two previous cases were followed by the brave ruling regarding taxpayer Renu Thikamdas Tharani (the “assessee,” again). As a reminder, Tharani was the beneficiary of a discretionary trust that held a Swiss bank account through a Cayman company, and the account was disclosed in Swissleaks.  The descriptions and arguments are so interesting that we limit ourselves to quoting some extracts.

This extract includes a description of Cayman Islands, which was ranked as the top worst offender in our 2020 Financial Secrecy Index:

It must be seen that underlying company of the Tharani family trust, i.e. GWU Investments Ltd is a company having address in the Cayman islands which is a tax haven and the account is maintained in HSBC, Geneva which is known for its banking secrecy laws and in recent times has faced investigation from various authorities in its role in facilitating tax evasion of its clients… We have also seen as to how the HSBC Private Bank (Suisse) SA has been indicted by several Governments worldwide and how it has even confessed to be being involved in money laundering.

One trick used by tax havens is to notify miscreants when they are being investigated, so they can quickly erase evidence. (The Financial Secrecy Index assesses this under Indicator 1).

It is an interesting coincidence, coincidence if it is, that within a short time of the information about the above account coming to the possession of the Government of India, this account was closed. Whatever assets were being held in this bank account were thus transferred back to GWU Investments Limited, a company based in Cayman Islands- a tax haven where it is almost impossible to find out about beneficial owners of a corporate entity…

It must also be a coincidence, coincidence if it could be, that the process of covering the tracks did not stop with closure of the HSBC account. It is a further coincidence that even the GWU Investments Limited, after the disclosure in respect of account, was closed as its name is struck off from the records of Registrar of Companies, Cayman Islands.

This next extract is long but fabulous, and shows that judges sometimes do use common sense. First, it describes why someone would use a secrecy jurisdiction like Cayman.

GWU Investments Ltd is a Cayman Islands entity, and it needs no special knowledge to know that, more as a rule rather than as an exception, the Cayman Island entities are owned by nominees of the beneficial owners. The operations carried out by these entities, are mainly to facilitate financial manoeuvring for the benefit of its clients, or, with that predominant underlying objective, to give the colour of genuineness to these entities. These offshore entities, which are routinely used to launder unaccounted monies, are a fact of life, and as much a part of the underbelly of the financial world, as many other evils. Even a layman, much less a Member of this specialized Tribunal, cannot be oblivious of these ground realities.

Indeed! Second, the ruling proposes not to believe everything a taxpayer claims, and that deploying secrecy should count against the taxpayer.

It is also inconceivable that a Rs 200 crore [around $27m at current rates] beneficiary in a trust will not know about who has settled that trust….The claim of the assessee…is to be examined in the light of real life probabilities and the very act of the assessee, in stalling the further probe, works against the assessee.
…
No reasonable person can accept the explanation of the assessee. The assessee is not a public personality like Mother Terresa that some unknown person, with complete anonymity, will settle a trust to give her US $ 4 million, and in any case, Cayman Islands is not known for philanthropists operating from there; if Cayman Islands is known for anything relevant, it is known for an atmosphere conducive to hiding unaccounted wealth and money laundering, and that does not advance the case of the assessee.

Good sense, again. As we have argued, especially in relation to complex ownership chains: secrecy should act against its creator, not in their favour. A person using complex secretive legal vehicles, bearer shares or failing to cooperate, shouldn’t get the benefit of the doubt:

This inference is all the more justified when we take into account the fact that the assessee has been non-cooperative and has declined to sign the consent waiver. One of the arguments raised by the assessee…that the assessee could not have performed the impossible act of signing consent waiver because she was not owner of the account is too naïve and frivolous to be even taken seriously.

The assessee has not submitted the trust deed or any related papers but merely referred to a somewhat tentative claim made in a letter between one Mahesh Tharani, apparently a relative of the assessee and the HSBC Private Bank (Suisse) SA- an organization with a globally established track record of hoodwinking tax authorities worldwide…Nothing is clear, nor does the assessee throw any light on the same
. . .

Something is rotten in the State of Denmark. There is a series of coincidences, right from the HSBC account being closed after the information contained in the base note coming out and to the underlying company being removed from the name of Register of Companies in Cayman Island, right from assessee living in complete denial about any knowledge about a HSBC Private Bank (Suisse) SA account in her name to her lack of information about the company which is holding US $ 4 million for her, and, despite assessee being purportedly so clean in her affairs, her thwarting any efforts of the income tax department to get at the truth by declining to sign the consent waiver form.

That’s robust, clear, and entirely sensible. One could argue that this judge has, in a few days’ work rejecting offshore trust skulduggery, built several Indian schools, or bought enough Coronavirus masks for a big chunk of India’s population.

Conclusion

Several lessons emerge.

On the one hand, the Supreme Court’s ruling shows that discretionary trusts are powerful ways for the wealthy to escape income, tax and inheritance tax.   

On the other hand, bold judges may apply common sense and restore justice by considering that:

• Tax havens are used for secrecy and thus enable financial crimes and other abuses,
• Trusts’ descriptions (“irrevocable”, or “discretionary”) aren’t to be taken seriously, and courts should look at reality. For example, if a person is the sole beneficiary, or they have control, or they secretly receive a distribution, or are mentioned somewhere, they should be regarded as the owners of the trust money and income and thus pay applicable taxes.
• If a person refuses to cooperate, sign a waiver for a bank to submit information, or claim not to know why an unknown person would give them millions of dollars, that should be used against the taxpayer, instead of them getting the benefit of the doubt.

But the big point here is that societies shouldn’t depend on bold and alert judges. Laws should change so that these abusive legal vehicles such as discretionary trusts, aren’t permitted to begin with.