Income Tax: A minority effect

Did we tell you about this terrific book that we have been reading? It’s got all the essential ingredients that a potboiler needs to have – drama, intrigue and suspense. The plots and sub-plots are so intricately woven by the author that each page will leave you guessing. We won’t give away more but we fully recommend reading The Income Tax Act, 1961. This week we are going to examine one of the abovementioned sub-plots of this thriller that deals with capital gains and clubbing.

It was actually Shiavux Mistry, author as well as a dear friend, who brought this issue to our notice first. Mistry is an authority on tax matters and the author of ‘Employer-Employee Guidelines, published by Snow White.

Take a situation where a minor has made sizable long-term capital gains through sale of jewellery inherited by him. The gains will be clubbed in the hands of the father whose income is higher than that of his wife. The father desires to take advantage of the exemption from longterm capital gains available u/s 54F by purchasing a residential house within the stipulated time.

The issue is — Should this new house be bought by the minor, since it is he who has earned the capital gains or should the father buy the house since the income is clubbed in his hands and it is he who is required to pay income tax thereon?

If the answer is that the minor should buy the house, then it would be difficult to sell it during the minority of the child.

Allahabad High Court in the case of CIT v Lalji Agarwal - (1993) 153CTR500 has given a landmark decision. Here the wife was a director of the company in which her husband was the managing director. Her salary was clubbed in the hands of the husband without allowing standard deduction.

The learned judge held, “If the wife herself had been the assessee, there would not have been any doubt as to her right to compute her net income. She is entitled to standard deductions and permissible other expenses. If that is so, we fail to see any good reason why gross income be clubbed u/s 64.”

22taxmann.com34 (Kolkata - Trib) 2012 DCIT Circle-8 v Rajeev Goyal has given the final solution.

Assessee, his minor daughter and minor son earned LTCG of Rs 551.27 lakh, Rs 49.74 lakh and Rs 39.57 lakh respectively. He invested Rs 50 lakh in his own name, Rs 49.50 lakh in the name of minor daughter and Rs 39.50 lakh in the name of his son in REC bonds to save tax on longterm capital gains. The Department clubbed LTCG earned by his minor children in the hands of the father but limited deduction u/s 54EC only to investment of Rs 50 lakh in his name and did not allow deduction for his minor children.

The honourable judge observed that a minor is an assessable entity distinct from his parents even though the income of the minor is clubbed in the hands of one of his parents. Thus, all the eligible deductions are to be allowed in the hands of the minor while computing the income of the minor and only the net taxable income is to be clubbed u/s 64 (1A). This Section says that in computing the ‘total income’ of an Individual all such income as arises or accrues to the minor child . . . .” The word ‘such’ means the total income of the minor, because ‘such’ is preceded by ‘total income’.

Therefore, unless and until the income of the minor child is computed, the clubbing provision will not apply.

We would like to point out that Section 80A(1) of Chapter VIA states, — “In computing the total income of an assessee, there shall be allowed from his gross total income, in accordance with and subject to the provisions of this Chapter, the deductions specified in Sections 80C to 80U.” Therefore, it is clear that for the purpose of taxation, the total income is arrived at by subtracting deductions from gross total income.

This decision has been extended by Madras HC to a discretionary trust in which shares of beneficiaries are ascertained, the net income of each beneficiary is to be aggregated and maximum marginal rate has to be applied on it CIT Chennai v Vummudi Bangaru Chetty [2012] 17 taxmann.com 196 (Madras).

Finally, N. Ram Kumar v ACIT Circle-6(1), ITAT Hyderabad Bench ‘A’ 2012 has observed that a bare reading of Sec. 54F(1) makes it clear that there is no requirement that the house has to be purchased in the name of the assessee only. It only requires that the assessee

must purchase a house.

In this case, it was he who had earned the capital gains and the house was purchased in the name of his minor daughter. This means that he could have purchased the house even in your or my name and claim the benefit!! This surely cannot be the intention of the law!

To sum

Through these columns we have been regularly pointing out the loopholes and lacunae that have crept in into the Income Tax Act over time. Earlier, the Act itself was going to be completely scrapped and replaced with a brand new Direct Tax Code. However, subsequently the authorities scrapped the idea of the Code itself. Be that as it may, we think it is important that these lacunae be addressed and the law suitably amended such that tax officers do not have to exercise ‘discretion’ and instead act as per what is spelt out in the law.

The authors may be contacted at wonderlandconsultants@yahoo.com