Mukesh Patel.in
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international tax expert / columnist / author / speaker

MAJOR TAX SAVING FOR MINOR’S INCOME

Using the medium of a discretionary trust, you can plan to save a decent tax of Rs.2,06,000 on income of Rs.10,00,000!

              Section 64(1A) of the Income-tax Act provides that “in computing the total income of any individual, there shall be included all such income as arises or accrues to his minor child.” With a view to ensure building up income for minors without attracting the above provisions relating to clubbing of income, one of the effective tools is a Private Discretionary Trust.

WHAT IS A DISCRETIONARY TRUST?

              A private discretionary trust is a trust wherein the beneficiaries and/or their shares in the income and assets of the trust are not specified in the trust deed. The trustees of such a trust are given full discretion in deciding these matters. The provisions of Section 164 of the Income-tax Act which govern the taxability of a private discretionary trust specify that income-tax shall be charged on the income of the trust at the ‘maximum marginal rate’ (currently 30.9%).

             However, the following two important exceptions to Section 164 which provide for charge of tax on the income of a discretionary trust at the ordinary rates in the case of an association of persons (i.e., at the same rates as in the case of an individual) merit careful attention:

  • Where none of the beneficiaries of the trust has any other income chargeable to tax (i.e. total income exceeding Rs.1,80,000 effective from FY 2011-12) and none of the beneficiaries is a beneficiary under any other trust.

  • Where the trust is declared by any person under his Will and such trust is the only trust so declared by him.

            Thus, if the discretionary trust falls under either of the above two exceptions, the benefit of a distinct and independent tax entity, liable to tax at ordinary rates, just like an individual, can be availed. Such a trust can play an important role in the arena of tax planning for minors. If minors are made beneficiaries under such a trust and the income of the trust is accumulated at the discretion of the trustees during their minority, no income can be said to accrue or arise to the minor beneficiaries and accordingly such income accumulated for the benefit of the minors cannot attract the clubbing provisions of Section 64(1A) of the Income-tax Act.

HOW THE TAX SAVING WORKS?

             Moreover, as compared to the language of Section 64(1) which provides for inclusion of ‘all such income as arises directly or indirectly,’ the language of Section 64(1A) provides for inclusion of ‘all such income as arises or accrues to the minor child.’ Thus the words ‘directly or indirectly’ as contained in the clubbing provisions in respect of non-minors under Section 64(1) are missing under the clubbing provisions for minors under Section 64(1A). Accordingly, it cannot be argued that the income of the trust in which a minor is a beneficiary is even indirectly attributable to the minor.

Illustration: The family of Mr. X comprises of himself, his wife Mrs. X and minor children Y & Z. Both Mr. X & Mrs. X have taxable income exceeding Rs.10,00,000, falling in the maximum tax bracket of 30.9%. Minor children Y & Z do not have any income. There is scope for generating investment income of Rs.11,00,000 for the family.

              If this income is planned directly either in the case of Mr. X or Mrs. X, the same would attract tax at the rate of 30.9% amounting to Rs.3,39,900. If this income is planned in the hands of the minors, the same would be liable for clubbing with Mr. X or Mrs. X, attracting the same tax liability of Rs.3,39,900.

              In this case a discretionary trust can be formed with the minors Y & Z as the beneficiaries and the investment income of Rs.11,00,000 can be planned to be generated in the hands of the trust. The status of a discretionary trust having been held as an ‘Individual’ for purposes of the Income-tax Act, the trust can plan to avail the benefit of deduction of upto Rs.1,00,000 under Section 80C, by investing in specified savings. The taxable income of the trust would thus work out to Rs.10,00,000. Since Y & Z do not have any income chargeable to tax and on the stipulation that they are not beneficiaries under any other trust, the discretionary trust would attract income-tax of Rs.1,33,900 at ordinary rates on the taxable income of Rs.10,00,00

               The trustees of the trust should accumulate this income in the case of the trust without distributing the same to the minor beneficiaries and hence the clubbing provisions would not be attracted. Considering that Mr. A’s family would have otherwise paid tax of Rs.3,39,900 in respect of the said income, the above planning would result in a net tax saving of Rs.2,06,000 (Rs.3,39,900 – Rs.1,33,900).

                In the context of the above illustration, it must be ensured that the trust plans to generate income, other than business income, because the overriding provisions of Section 161(1A) of the Income-tax Act provide for charge of income-tax at the maximum marginal rate, if the total income of any trust includes any business income.

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