This week, we share with readers an interesting issue that came up before us in respect of one of our clients. The client, Anand, is an active capital market investor. Over time, he has invested funds for himself and for his family. For the current financial year, he earned taxable long-term capital gains (LTCG) from the sale of debt mutual funds of Rs 28 lakh. Similarly, his wife earned an LTCG of around Rs 20 lakh, and his two minor children earned LTCG of around Rs 15 lakh each. Since the income earned by his family (wife and children) was from the capital gifted to them by Anand himself, such income was to be included or added to Anand’s income for tax purposes. This is what is known as the clubbing provision under the ITA.
So far so good. However, now arises the question whether to save the capital gains tax, can Anand invest the LTCG amount earned by each person in Sec 54EC bonds? Remember, Sec 54EC bonds come with a maximum ceiling of Rs. 50 lakh per financial year. In this case, the total LTCG is Rs 78 lakh (Rs 28 + 20 + 15 + 15 lakh). So, is the clubbing to be carried out before considering the deduction from the investment or after? In the former case, the maximum amount that may be invested is Rs 50 lakh thereby making Rs 28 lakh taxable. In the latter case, there would be no tax liability since the bonds will offer complete tax exemption.
In fact this was the very issue that the Kolkata Tribunal Bench had to take a decision on (Deputy Commissioner of Income-tax v Rajeev Goyal & Others, IT Appeal Nos. 951 & 963 (Kol.) of 2011)
The brief facts of the case were that the taxpayer Mr. Shankar Sharma had earned taxable LTCG from sale of shares of around Rs 5.50 crores. Similarly, his minor daughter earned LTCG of around Rs 49.70 lakh while his minor son earned LTCG of Rs 39.50 lakh. Mr. Sharma invested Rs 50 lakh in Sec 54EC bonds issued by the 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 deduction under Sec 54EC only to investment of Rs 50 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 Rs 50 lakh imposed by the proviso to section 54EC (1).
Aggrieved, the assessee preferred appeal before CIT(A), who in fact allowed the claim of assessee and deleted the disallowance. In turn, the Revenue Department appealed to the Tribunal.
The Revenue 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 being the individual Shri 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, counsel for the taxpayer argued that the word 'person' has been defined in section 2 (31) of the ITA 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 ITA in the hands of his parents, he/she is to be considered separate than his parents. The clubbing provisions of the ITA as detailed in Sec 64 (1A) specify that in computing the total income of any individual, there shall be included all such income as arises or accrues 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 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 ITAT in the case of Bajaj Ashok Chunnilal, wherein it held that "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, Mumbai Bench of the Tribunal in the case of Smt. Babita P. Kanungo, 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 by finally relying on the case of of Segu Harnath, wherein the Hon'ble A.P. 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 opined that 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 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.
To Sum
With the sheer number of judgments that exist on this matter, it is incomprehensible as to why the authorities fail to insert a clarification or explanation to Sec 64 (1A) specifying the position of law on the issue. This will save money, time and resources of all stakeholders concerned and once and for all remove all ambiguity. Perhaps the proposed new DTC can incorporate the same.
The authors are leading financial advisors. Write to them at [email protected]