Jigar M. Patel
International Tax Attorney
A major stumbling block in capital formation for the minors are the clubbing provisions under Section 64(1A) of the Income-tax Act, which provide that in computing the total income of an individual, there shall be included all such income as arises or accrues to his/her minor child. It has been further provided that the income of the minor will be included in the income of that parent, whose income is greater.
Exceptions to the Clubbing Provisions
Two exceptions have been provided in this regard:
- Income derived from manual work done by a minor.
- Income derived by a minor from any activity involving application of his skill, talent or specialized knowledge and experience (e.g. income of child artistes).
An exemption of up to Rs. 1,500 in respect of each minor child can be availed by the parent in whose case clubbing is attracted.
Investment of Minor’s Funds in 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 exempt from Income-tax, viz., investment in a Public Provident Fund (PPF) Account, Sukanya Samruddhi Yojana (SSY), Tax-free Bonds and the like.
Investment of Minor’s Funds in Growth Instruments
Investing minor’s funds in Growth Schemes of Mutual Funds is also an effective strategy to defer the impact of the clubbing provisions, since there would be no receipt of any annual income. In such a case, the value of the units would keep on growing and liability for capital gains on appreciation in the value of investment would get attracted, only on actual redemption of the units.
Planning Income through a Discretionary Trust
Another effective tool to counter clubbing is a Private Discretionary Trust. A private discretionary trust is a trust wherein the beneficiaries and/or their shares in the income and assets of the trust are not specified in the trust deed. The trustees of such a trust are given full discretion in deciding these matters.
While provisions of Section 164 of the Income-tax Act governing taxability of a private discretionary trust provide for charge of income-tax on income of such a trust at the ‘maximum marginal rate,’ an important exception to this Section prescribes charge of tax on income of a discretionary trust at ordinary rates where none of the beneficiaries of the trust has any other income chargeable to tax (i.e. total income exceeding Rs. 2,50,000) and none of the beneficiaries is a beneficiary under any other trust. To illustrate, the income-tax liability in case of such a Trust on taxable income of Rs. 15,00,000 for Assessment Year 2024-25 would be Rs. 1,56,000 at an average rate of 10.4% in comparison to Rs. 4,68,000, which could be attracted in case of clubbing in the case of a parent in the tax-slab rate of 31.2%.
If minors are made beneficiaries under such a trust and the income of the trust is accumulated at the discretion of the trustees during their minority, no income having accrued or arisen to the beneficiaries, clubbing provisions cannot be invoked.
However, while resorting to this planning, it must be ensured that such a Trust plans to generate income, other than business income, because the overriding provisions of Section 161(1A) provide for charge of income-tax at the maximum marginal rate, if the total income of any Trust includes any business income.
