Last Updated on January 24, 2021 at 9:48 pm
A few days ago, a discussion led to an interesting question in the freefincal goal-based investing Facebook group: Can we buy mutual funds in the name of my minor child; wait until she becomes a major to redeem? She will then have to pay tax on capital gains. We discuss the rules in this regard and if this is practically feasible.
Acknowledgements: Several people contributed to this article. Senthil Nathan for the question; Sayan Sircar, Sirish Dhananjaya, Ragesh and Anath for discussions; Ashal Jauhari for answering the question.
Madan for doing the initial research and writeup (his full article will be published later). Madan is CA Final student and CFA L1 interested in corporate finance, personal finance, macroeconomics and individual taxation. CA Amit Porwal for expert comments and insights.
Amit Porwal, is a Delhi based practising Chartered Accountant, having more than 18 years of post-qualification experience. In the initial phase of his career, he worked with some of the largest private sector banks of India, as a credit appraiser in mortgage loans, and after that as a Relationship Manager for Mid Corporates Segment, responsible for both asset side and liability side acquisition and management, before setting up his practice.
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When the child is a minor
Many of us would be aware of the income clubbing rules. If you invest in an asset taxed as “income” or “income from other sources” – that is, as per slab, investing in the name of the minor child has little benefit.
The income earned out of such an investment is clubbed to the income of the parent who has a higher taxable income, unless the income is out of their skill/talent individually, i.e. the minor child has earned income on the amount gift through manual labour or his skill (this area of contention is prone to litigation!)
Example: You invest in an FD in the name of your minor child, you pay tax on the interest. You buy a home in the name of the minor child and receive rent from the same, or if you buy a stock and receive dividends, you pay tax on it. If you sell a stock or mutual fund held in their name when they are a minor, you pay the capital gains tax.
When the child becomes a major
For an asset taxed as capital gain if I defer redemption until the child becomes major, the law allows the taxation to be in the name of the major child as explained by Ashal in the group and Madan from his research.
I asked Amit Porwal the following. The money technically belongs to the child, but when we compute CG tax, the date of acquisition is when they were a minor. Is this not a loophole that can be exploited even if the transfer of assets is irrevocable?
Response:– Agree. This is a loophole, or a tax planning tool, whatever way we wish to name it. Even this has a limited role in tax planning. Because deferment of redemption would result in LTCG, which anyways is taxed at special rates, whether in the hands of the major child, or the donor parent themselves. The only saving that one would benefit from would the basic exemption limit*, that too if such major child does not have any other incomes at the time of redemption. While the major child may be able to offset these limits against LTCG, the parent may not do so due to various other incomes.
* The basic exemption limit is currently 2.5 lakhs. For a person with no other source of income, capital gain up to this amount is tax-free.
Let us think of a hypothetical situation – where we defer the redemption, and then book the entire CG at one go once the child is major and does not have any other incomes. The computed CG says, Rs 20 Lacs. The gain computation would have been the same, even if the asset was not transferred to the minor child. however, the minor turned major child would be able to take advantage of the basic exemption limit of “x” amount per the provisions at that time. That’s it! The rate of taxation and all would remain the same in either case otherwise. As per today’s provisions, it would have made a difference of max 50 K of tax liability if LTCG is from Debt funds.
Next, we can assume that instead of booking all the gains at one go, we do it in parts even after the child is a major. In such a case, the benefit of basic exemption limit shall be available for each AY when CG is booked, only so long as the child does not start earning himself. Therefore the utility is limited, and hence the loophole isn’t that critical. But yes, tax planning can be done to some extent definitely, for a few years after the child attains majority.
One must keep in mind that the transfer of the money/assets by way of Gift should be irrevocable & absolute. The transferor shall not exercise any authority or control over the assets or the incomes arising therefrom. This is a big risk!
To summarise, even if there is some tax benefit in buying mutual fund units in the name of minor children, the benefit is limited even if we delay redemption until they turn 18+. Firstly, many children enter college (or get admission) before they turn 18. So a bulk of the capital gains tax would be in the name of the parents.
Secondly, we cannot simply invest and forget capital assets. The portfolio has to be rebalanced, the equity allocation (or allocation in long-duration debt funds) reduced periodically. The taxation associated with this would be in the name of the parents. So effectively the residual benefit of investing in the name of the child is quite small.
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