Jigar M. Patel
International Tax Attorney
Tax Provision for Clubbing of Minor’s Income
Section 64(1A) of the Income-tax Act provides that “in computing the total income of any individual, there shall be included all such income as arises or accrues to his minor child.” The income of the minor is required to be included in the income of that parent whose total income is greater.
In this context it is pertinent to note that if no income either arises or accrues to the minor during his minority or if such income is exempt from tax, there would be no effective or adverse impact of the clubbing provisions.
Escape Clubbing Net via Tax Free Investments
The impact of the clubbing provisions in respect of minor’s income can be effectively blunted by investing the minor’s funds in such investments, the income of which is totally free from Income-tax. Thus, investments in Public Provident Fund (PPF) Account or Sukanya Samruddhi Yojana (SSY) opened in the name of a minor have been a popular mode of capital building for minors, since the return on PPF or SSY being completely tax-free u/s. 10, it effectively escapes the clubbing net.
Invest in Growth Instruments to blunt Clubbing Impact
Investing minor’s funds in Growth Schemes of Mutual Funds is an effective strategy to blunt the impact of the clubbing provisions, since there would be no receipt of any annual income. In such a case the Net Asset Value (NAV) of the Mutual Fund units would keep on growing and even the liability for capital gains on the appreciation in the value of investment would not be attracted until the actual redemption of units takes place.
Plan Deferring Income beyond Minority
Another effective way of lawfully avoiding the clubbing provisions is planning investment of the minor’s funds in long term cumulative income yielding schemes. It must be borne in mind that while clubbing provisions are attracted in respect of “all income accruing or arising to a minor,” but, if no income either arises or accrues to the minor during his minority, there would be no question of any clubbing. Taking shelter under the above legal interpretation, what can be smartly done is to defer the arising or accrual of income in the hands of the minor until he attains majority.
An interesting issue arose before the Bangalore Bench of the Income-tax Appellate Tribunal (ITAT), where the ITAT had occasion to consider a situation where the father debited interest payable to his minor son in the P & L A/c of his business and such account was credited to the minor’s account, but not actually paid. The father contended that since the minor was following the cash system of accounting, such amount of interest could not be taxed until actually paid. The Assessing Officer added the entire amount on the ground that the taxpayer cannot claim expenditure on mercantile basis and treat the income in respect of the same item on cash basis.
The Tribunal, while allowing the appeal in favour of the father, held that father and son are two different entities and the minor child can follow his own method of accounting. For computing the income of the minor child as per the charging Section 5, the same has to be computed considering the method of accounting under Section 145 employed in the case of the minor. The nature of income in the hands of the minor retains the same character, even when required to be clubbed in the hands of the parent. The ITAT concluded that if the income does not fall in the gamut of Section 5, the same cannot be made taxable by invoking the provisions of Section 64 (1A).
