Should you club a minor’s income on net basis or gross?

Under the Income Tax Act, the income that arises or accrues to a minor child is clubbed with the income of the parent whose total income is greater.

But is such income to be clubbed on a gross basis (prior to giving effect to tax deductions) or on a net basis (after deductions)? The question has many a taxpaying parent befuddled.

The Kolkata Tribunal Bench took a decision on this recently (Deputy Commissioner of Income-tax v Rajeev Goyal & Others, IT Appeal Nos. 951 & 963 (Kol.) of 2011).

The brief facts of the case were as follows.

The taxpayer, Shankar Sharma, had earned taxable long-term capital gain (LTCG) from sale of shares of around Rs5.50 crore. Similarly, his minor daughter had earned LTCG of around Rs49.70 lakh while his minor son earned LTCG of Rs39.50 lakh. Sharma invested Rs50 lakh in Sec. 54EC bonds issued by REC while his daughter and son invested their entire capital gain amount in such bonds.

The assessing officer clubbed the LTCG earned by the minor children in the assessee’s hands, but limited deduction under Sec 54EC only to an investment of Rs50 lakh in the assessee’s name and did not allow deduction for investment in REC bonds made by his minor children citing the investment limit of Rs50 lakh imposed by the proviso to section 54EC(1).

Aggrieved, the assessee preferred appeal before CIT(A), who allowed the claim of the assessee and deleted the disallowance. In turn, the Revenue Department appealed to the Tribunal.

The Revenue’s stand was that the benefit of deduction is available to an assessee and in the present case, there was only one assessable entity, the individual Shankar Sharma. His children, being minors could not be termed as independent assessees or persons and their income is only clubbed in the hands of the main assessee.

On the other hand, the counsel for the taxpayer argued that the word ‘person’ has been defined in Section 2(31) of the Income Tax Act, which includes an individual and there cannot be any dispute that minor children are individuals separate from the parent.

After hearing rival submissions, the Bench ruled in favour of the assessee. It held that even though a minor’s income is clubbed under Sec 64(1) of the Income Tax Act in the hands of his parents, he/she is to be considered separate from his parents. The clubbing provisions of the Act as detailed in Sec 64(1A) specify that in computing the total income of any individual, all such income as arise or accrue to his minor child is to be included.

The word ‘such’ means the total income of the minor because ‘such’ is preceded by the word total income.

Furthermore, the words ‘total income’ have been defined under Sec. 2(45) of the ITA to mean the total amount of income as computed in the manner laid down in the Act.

The Bench also quoted the decision of the Bangalore Bench of the Income Tax Appellate Tribunal in the case of Bajaj Ashok Chunnilal, wherein it was held that “unless and until the income of the minor child is computed, the clubbing provision will not apply”.

Furthermore, in the case of Babita P Kanungo, the Mumbai Bench of the Tribunal had held, “From the above, we find that in computing the total income of an assessee, all such income as arises or accrues to his minor child is to be clubbed. The words “all such income” in this section refer to total income and we are of the considered opinion that for giving effect to this section, first the total income of the minor children is to be computed and then, such total income only of the minor children is to be clubbed with the income of the parent.”

Quoting a few other decisions, the Bench concluded by finally relying on the case of Segu Harnath, wherein the Andhra Pradesh High Court had held, “Where the assessee was a partner in a firm and his minor daughter was admitted to the benefit of partnership in the firm and assessee borrowed funds and invested the same in the partnership firm in the name of his minor daughter, the interest payable by the assessee on capital borrowed by the assessee on behalf of the minor daughter was deductible under section 67(3) from the share income arising to the minor child and it was only the resultant income, after deduction, which was to be included in the total income of the assessee under section 64(1) (iii)”.

The Kolkata Bench said the above judgment clearly showed that even if the income of the minor is clubbed with the income of the parent, all the deductions are to be allowed while computating the income of the minor and only the net taxable income is to be clubbed under section 64.

In view of the above, the claim of the assessee was allowed and the AO was directed to recompute the long-term capital gains accordingly.

More haze
The underlying principle in the above case may be equally applied for cases where income of the spouse is to be clubbed with that of the other spouse. With the sheer number of judgments that exist on this matter, whether the income to be clubbed is on a gross or a net basis is clearly not a settled issue. To save money, time and resources of all stakeholders concerned, perhaps the authorities should consider inserting an Explanation to Sec. 64(1A) specifying that clubbing will apply only to net income after considering all available tax deductions. This will, once and for all, remove all ambiguities.

The writer is director, Wonderland Consultants, a tax and financial planning firm. He may be contacted at sandeep.shanbhag@gmail.com