Last week when a two-month-old daughter of a wealthy family got a PAN card, it created headlines. And while she may still be a tiny toddler and your hand might be her only security blanket, gradually she will find her feet.
So give her the financial support, transfer your wealth to her and make investments in her name. Each of those decisions has tax implications. Here we take a look at each one of them:
Minor's income
Income tax: Sums of money received by a minor (less than 18 years) from her close family and relatives are not treated as her income. But when you invest that money on her behalf and in her name, for tax purposes, income or capital gains arising from that is not treated as her income.
It is treated as yours, which effectively increases your taxable income and pushes you in a higher tax bracket.
Of course, this wasn't the case till 1993, when only income arising from assets transferred by the parents or the father's parents were to be included into the income of the transferor parent or grand parent.
Income other than this was taxed directly in minor's hands. That way, benefit of the basic exemption and initial lower tax slabs was obtained to avoid paying more by way of taxes. This loophole was plugged in 1993.
Now, section 64(1A) stipulates that all incomes of minor children must be included in the income of the parent who has a higher income. Say, Aashi, aged 7, has an interest income of Rs 75,000 in a year. That same year, Ushma, her mother, had an income of Rs 9 lakh (Rs 900,000) and his father Gautam, Rs 7 lakh (Rs 700,000).
Aashi's income will be clubbed with that of Ushma's, since she has earned more than Gautam that year.
As a result, Aashi the minor, won't be entitled to the basic exemption of Rs 110,000 or the section 80C tax deduction benefit up to Rs 1 lakh (Rs 100,000). The only exemption available is under Section10(32), under which an exemption of Rs 1,500
There are two exceptions to this rule. One, children with specified disabilities. Two, where the minor has derived income by doing some work or using her talents. For instance, a minor working in a film or a TV show, or selling a painting for a price with get taxed at the hands of the minor, who then gets the benefit of basic exemption of Rs 1 lakh and also, the section 80C tax deduction.
Wealth tax: Even for wealth tax purposes, a minor's wealth is clubbed with that of her parent whose wealth is higher.
Broadly, wealth tax is now payable only on unproductive wealth as represented by the market value of immovable property, open plot of land (not being agricultural), cash in excess of Rs 50,000, jewellery and car.
So, if Ushma's taxable net wealth is Rs 13 lakh (Rs 1.3 million), Gautam's taxable net wealth is Rs 11 lakh (Rs 1.1 million) and the market value of jewellery of Aashi is Rs 4 lakh (Rs 400,000), Ushma's will have to pay tax on Rs 17 lakh (13+4). The basic exemption for wealth tax is Rs 15 lakh (Rs 1.5 million) and the tax rate is 1 per cent. So, Ushma's will have to pay Rs 2,000 [1 per cent of Rs 2 lakh (17-15)] as wealth tax.
Mutual funds investments: The growth option of equity funds is a very tax-efficient investment option for minor children.
Long-term capital gains (more than 12 months ) arising from equity funds are tax-exempt. In a growth option, your investment keeps accumulating till you withdraw. And if you were to withdraw the sum only when the child becomes an adult, then the redemption proceeds will represent the child's own wealth.
Then it will be not be clubbed with anyone's income. Also, there will be no taxation as the investment period exceeds 12 months.
The writer is a chartered accountant.