Ambiguity over clubbing minor's income

Under the Income Tax Act (I-T Act), the income of a minor child is clubbed with that of one of his/her parent, whoever earns more.

But the question that arises is whether such income is to be clubbed on a gross or on a net basis after deduction (as per the individual's slab) – an issue that the Kolkata Tribunal Bench had to address recently.

Shankar Sharma had earned taxable long-term capital gains (LTCG) from sale of shares worth Rs 5.5 crore. His minor daughter earned LTCG of around Rs 49.7 lakh, while his minor son earned LTCG of Rs 39.50 lakh.

Sharma invested Rs 50 lakh in Section 54EC bonds issued by REC, while his daughter and son invested their entire capital gain amount in such bonds. The assessing officer (AO) clubbed the LTCG earned by the minor children in the assessee's hands but limited deductions under Section 54EC only to the investment of Rs 50 lakh in Sharma's name and did not allow deduction for investment in REC bonds made by the children citing the investment limit of Rs 50 lakh under Section 54EC(1).

Sharma preferred an appeal before the Commissioners of Income Tax (Appeals) or CIT(A), who allowed the claim and deleted the disallowance. In turn, the revenue department appealed to the Tribunal.

The department's stand was that the benefit of deduction is available to an assessee and in the present case there was only one assessable entity, Sharma.

His children, being minor, could not be termed as independent assessee and their income was only clubbed in the hands of the main assessee or Sharma.

On the other hand, Sharma's counsel argued the word 'person' had been defined in Section 2(31) of the I-T Act which includes an individual and there cannot be any dispute that minor children are individuals separate from the parent.

The bench ruled in favour of the assessee. It held that even though a minor's income is clubbed under Section 64(1) in the hands of his parent, he/she was to be considered separate from his parents.

The clubbing provisions of the I-T Act as detailed in Section 64 (1A) specifies that in computing the total income of any individual, these shall be included all such income as arises to his minor child. The word 'such' means the total income of the minor, because 'such' is preceded by the word total income.

Further the words 'total income' have been defined under Section 2(45) 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 ITAT, wherein it had held, "Considering all the aforesaid decisions it can be held that unless and until the income of the minor child is computed, the clubbing provision will not apply." Further, the Mumbai bench of the Tribunal in a case had held, "From the above, we find that in computing 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 finally relying on an Andhra Pradesh High Court ruling, which said, "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 opined that the above judgment clearly showed that even if the income of the minor was clubbed with the income of the parent, all the deductions are to be allowed while computation of 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.

This may be applied for cases where the income of spouses' is to be clubbed. 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, the authorities could consider inserting an explanation to Section 64(1A) specifying that clubbing would apply only to net income after considering all available tax deductions.

This will, once and for all remove all ambiguity.

<I>The writer is director, Wonderland Consultants</I>