In an era where financial literacy is gaining momentum, parents are increasingly looking to secure their child’s future through early investments. One of the popular ways to do this is by opening a minor demat account. These accounts allow parents to invest in the stock market, mutual funds, or other securities on behalf of their minor children. While this is a great way to build wealth for a child’s future, parents must also consider the tax implications associated with a minor demat account.
This blog delves into everything parents need to know about the tax liabilities, benefits, and rules associated with minor demat accounts.
Understanding a Minor Demat Account
A minor demat account is an investment account opened in the name of a child under the age of 18, with a parent or legal guardian managing the account. Parents can use these accounts to invest in shares, bonds, mutual funds, and other financial instruments. The objective is to begin building a financial cushion early in the child’s life that can later be used for education, marriage, or other future needs.
While minor demat accounts offer several advantages, including early exposure to the stock market, parents should be aware of the tax rules that apply to income earned from such investments.
Tax Implications: Income Clubbing Provisions
One of the key aspects of taxation for a minor demat account is income clubbing. According to the Income Tax Act, 1961, any income generated through investments made in the name of a minor child is clubbed with the income of the parent who earns a higher taxable income. This is done to prevent parents from avoiding taxes by investing in their child’s name.
When Does Clubbing Apply?
Clubbing applies to all forms of income earned from the investments in the minor’s demat account. This can include:
- Dividends from stocks
- Interest from bonds or other fixed-income securities
- Capital gains from the sale of securities
For instance, if the parent with the higher income earns ₹10 lakhs annually and the investments in the minor’s account generate an income of ₹50,000, this amount will be added to the parent’s taxable income and taxed at the applicable rate.
Exemption Under Section 10(32)
Parents can, however, benefit from a minor-specific exemption. Under Section 10(32) of the Income Tax Act, income up to ₹1,500 per year per child is exempt from tax. This means that if the income generated from the minor’s investments is ₹1,500 or less, it will not be added to the parent’s taxable income. For two children, this exemption can amount to ₹3,000 annually. Any income above this amount is clubbed with the parent’s income and taxed accordingly.
Types of Income and Their Taxation
Different types of income from a minor demat account are taxed differently based on the nature of the income. Let’s explore the common types of income generated from investments and their respective tax treatments.
1. Dividends
Dividends earned from stocks or mutual funds are considered part of the minor’s income. Since the dividend distribution tax (DDT) was abolished in 2020, dividends are now taxable in the hands of the recipient. Thus, dividends earned in a minor’s account will be clubbed with the parent’s income and taxed at their applicable income tax slab rate, after taking the ₹1,500 exemption into account.
2. Interest Income
If the minor’s account holds bonds, fixed deposits, or debt instruments, the interest earned is also clubbed with the parent’s income. Similar to dividends, interest income will be taxed at the parent’s income tax slab rate. However, specific instruments like Public Provident Fund (PPF) or Sukanya Samriddhi Yojana (SSY) offer tax-exempt interest, making them popular choices for parents looking to save tax on their child’s investments.
3. Capital Gains
Any capital gains from selling securities, such as stocks or mutual funds, will also be clubbed with the parent’s income. The nature of capital gains—whether short-term capital gains (STCG) or long-term capital gains (LTCG)—determines the tax rate applicable.
- Short-Term Capital Gains: Gains from the sale of equity shares or equity-oriented mutual funds held for less than one year are taxed at 15%.
- Long-Term Capital Gains: Gains from the sale of such investments held for more than one year are taxed at 10% if the gains exceed ₹1 lakh in a financial year.
Parents should take note that any capital gains from their minor child’s demat account will be added to their own capital gains and taxed accordingly.
Tax Implications When the Child Turns 18
Once the minor turns 18, the tax situation changes. Upon reaching adulthood, the child is treated as an independent taxpayer. Any income earned from investments in the demat account will no longer be clubbed with the parent’s income but will instead be taxed in the hands of the child.
This can be advantageous if the child does not have any other significant income, as the basic exemption limit of ₹2.5 lakhs applies, allowing the child to earn tax-free up to this amount.
Gift Tax Considerations
Many parents or grandparents may gift securities or money to the child for investment purposes. It’s important to understand the tax treatment of such gifts.
- Gifts from Relatives: Gifts from parents, grandparents, or other close relatives are not taxable, regardless of the amount. Therefore, parents can gift any amount of money or securities to their child’s demat account without incurring tax liabilities.
- Gifts from Non-Relatives: If the gift is from a non-relative and exceeds ₹50,000 in a financial year, it will be taxed as income in the hands of the parent managing the minor’s demat account.
Gifts within the family can be a tax-efficient way of transferring wealth, but it’s crucial to document such gifts properly to avoid any complications with tax authorities.
Tax-Saving Opportunities
While tax liabilities can be significant, parents can also explore tax-saving strategies when managing a minor’s demat account. Here are a few ways to minimize tax burdens:
- Investing in Tax-Exempt Instruments: Instruments like PPF, SSY, and Tax-Free Bonds can help reduce the tax liability since the interest earned is exempt from taxes.
- Utilizing the ₹1,500 Exemption: Parents should aim to maximize the tax exemption under Section 10(32) by carefully planning the minor’s income.
- Choosing Tax-Friendly Investment Vehicles: Equity-oriented investments can be more tax-efficient for long-term capital gains, as they attract lower tax rates compared to debt instruments or fixed deposits.
Bottom-line
Opening a minor demat account is a great way to secure your child’s financial future, but it’s essential to understand the tax implications involved. Income from investments made through the minor’s account is typically clubbed with the parent’s income and taxed accordingly. However, parents can benefit from exemptions like Section 10(32) and take advantage of tax-saving strategies to minimize their tax liabilities. By carefully planning investments, parents can ensure they not only grow wealth for their child but also manage taxes effectively.
Always consult a tax professional for personalized advice, as tax laws are subject to change.
