Section 164 Income Tax Act: Tax on Discretionary Trusts and Beneficiaries
Section 164 of the Income-tax Act, 1961 governed the taxation of income held by representative assessees where beneficiaries or their individual shares were not identifiable or determinable. The corresponding provision for tax years beginning on or after 1 April 2026 is section 307 of the Income-tax Act, 2025.
What is a discretionary trust?
A discretionary trust generally allows trustees to determine the allocation of income among beneficiaries, rather than assigning each beneficiary a fixed, ascertainable share. For tax purposes, the decisive question is whether the beneficiary and the share are identifiable under the governing instrument or court order, not merely the label used for the trust.
Under section 164(1), income held by persons described in section 160(1)(iii) and (iv) is ordinarily taxed at the maximum marginal rate where income is not specifically receivable for one person or the beneficiaries' shares are indeterminate or unknown. Section 307(1) of the 2025 Act follows the same general approach by referring to section 303(1)(c) and (d).
Definitions and important statutory provisions
Representative assessee
A person legally accountable for income received or receivable on behalf of another, including specified receivers, managers and trustees. See section 160 of the 1961 Act and section 303 of the 2025 Act.
Maximum marginal rate (MMR)
Under section 2(29C) of the 1961 Act, the maximum marginal rate is the income-tax rate, including applicable surcharge, for the highest slab of income of an individual, association of persons or body of individuals, as specified by the relevant Finance Act. Applicable cess and other statutory rules must also be considered in calculating actual tax.
Identifiable beneficiaries and ascertainable shares
Explanation 1 to section 164 requires the relevant beneficiary and the individual share to be expressly stated and ascertainable in the court order, trust instrument or wakf deed on its date. Section 307(5) of the 2025 Act contains corresponding rules.
Exceptions to the maximum marginal rate
Section 164(1) allowed taxation as an association of persons instead of at MMR in specified situations, subject to the statutory conditions:
- Where the conditions concerning other taxable income and interests in other trusts of the beneficiaries are satisfied.
- Where income is receivable under the settlor's only trust declared by will.
- Where a qualifying bona fide non-testamentary trust was created before 1 March 1970 for dependent relatives of the settlor or dependent members of a Hindu undivided family.
- Where income is held by trustees of qualifying bona fide employee provident, superannuation, gratuity, pension or similar funds.
These are exceptions, not automatic exemptions. Section 307(2) of the 2025 Act states the corresponding AOP-rate cases. The exact facts and conditions must be checked for the relevant tax year.
Business income
Under the business-income qualification in section 164(1), read with section 161(1A), the exception is generally restricted where trust income includes business profits. The special testamentary trust exception for a dependent relative may apply where all its requirements are met. Section 307(3) and (4) of the 2025 Act expressly address business income and that exception.
Charitable and religious trusts: section 164(2) and (3)
For a trust holding property wholly for charitable or religious purposes, section 164(2) provided for AOP-basis taxation of relevant income not exempt under sections 11 or 12. Where exemption was denied because of section 13(1)(c) or (d), the statutory proviso imposed the maximum marginal rate on the relevant income or part.
For a trust holding property partly for charitable or religious purposes, section 164(3) distinguished the charitable portion, after allowable exemption, from the non-charitable portion with unknown beneficiary shares. The latter generally attracted MMR, subject to the specified exceptions and the rules relating to business income and section 13 violations.
Charitable and religious trusts under the 2025 Act must be considered under the new Act's applicable special regime rather than assuming every old section reference has the same number.
Illustrations
Example 1: Unknown shares
A trust deed names three beneficiaries but permits the trustee to allocate all income in any proportion. Where their individual shares are not ascertainable under the statutory test, the income ordinarily attracts MMR unless a specific exception applies.
Example 2: Fixed shares
If the trust deed identifies two beneficiaries and fixes their income shares at 60% and 40%, the shares are ordinarily determinate. The tax treatment should be examined under the representative assessee provisions, including section 161, rather than presuming section 164(1) applies.
Example 3: Charitable trust with a violation
Where income otherwise eligible for charitable exemption is denied exemption due to a specified section 13(1)(c) or (d) violation, section 164(2) or (3) can impose MMR on the affected income. The exact amount and statutory treatment depend on the facts and applicable year.
Section 307 of the Income-tax Act, 2025
The 2025 Act, effective from 1 April 2026, places the principal rule for unknown beneficiary shares in section 307. Sub-section (1) addresses MMR, sub-section (2) addresses qualifying AOP-rate exceptions, sub-sections (3) and (4) address business income, and sub-section (5) addresses identification of beneficiaries and their shares.
For earlier years and proceedings saved under the transition provisions, the 1961 Act may remain relevant. Always identify the tax year before applying either provision.
Official statutory sources
Frequently asked questions
Does every trust pay tax at the maximum marginal rate?
No. The outcome depends on the beneficiary shares, trust income, exemptions, and specific exceptions. A determinate trust and an eligible charitable trust may be treated differently.
Which provision replaces section 164 under the 2025 Act?
Section 307 addresses the taxation of income where beneficiaries or their shares are unknown. The new Act also contains separate provisions relevant to charitable institutions.
Is a trust with named beneficiaries always a specific trust?
No. Naming beneficiaries alone does not establish their individual shares. The governing instrument or order must satisfy the statutory ascertainability rules.