Fact-check: Can you save capital gains tax by gifting mutual fund units to family members?

In the past few days, there have been several posts doing the rounds on social media, claiming that mutual fund investors can save long-term capital gains (LTCG) tax by gifting their units to close relatives in the family. However, such claims are misleading.

While one is allowed to gift mutual fund units to certain specified relatives without paying tax at the time of gifting, the sale of such units by the relative in the future can lead to tax implications. Let's understand this in detail:

As per Section 56(2)(x) of the Income-tax Act, 1961, gifts received from specified relatives are fully exempt, irrespective of value. Therefore, transferring or gifting mutual fund units to specified relatives, such as spouse, parents, siblings, children, grandchildren, lineal ascendants/descendants, etc., does not trigger any tax in the hands of the recipient.

An investor may use the above provision of the income tax law to structure tax-efficient transfers of mutual fund units within the family.

However, such transfers do not fully eliminate the tax liability.

"Yes, an investor may structure tax-efficient transfers of mutual fund units within the family, but the tax impact depends on the relationship between the donor and the recipient," said CA Dr Suresh Surana.

"However, it is pertinent to note that gifting does not eliminate tax on the income generated from these units," he added.

According to Dr Surana, the following clubbing provisions can apply after the sale of gifted units by the specified relatives:

• In accordance with Section 64(1)(iv) and Section 64(1A) of the IT Act, if an individual gifts mutual fund units to a spouse or to a minor child without adequate consideration, any income arising from such transferred asset is required to be clubbed with the income of the transferor.

• Where assets are gifted to the daughter-in-law without adequate consideration, Section 64(1)(vi) mandates clubbing of income in the hands of the transferor.

• In the case of minor children, any income (except income from manual work or skill-based activities) is taxable in the hands of the parent with the higher total income, after allowing an exemption of ₹1,500 per child per year under Section 10(32) of the IT Act.

However, in case of gifting to other specified relatives, the clubbing provisions may not apply if there is no transfer of income-yielding assets between restricted relationships covered under Section 64. In such cases, the income generated from the gifted amount may be taxed independently in the hands of the recipient, subject to applicable slab rates.

"The act of gifting itself is not a “transfer” under Section 47(iii) and therefore does not trigger capital gains tax at the time of gifting. Accordingly, while gifting mutual fund units can be a legitimate tax-planning tool, the implications of Section 56(2)(x) and clubbing provisions u/s 64 need to be considered to ensure that the intended tax benefit is achieved. Of course, the mechanism of transferability of mutual funds held either in demat or non-demat, from the donor to the donee needs to be ascertained," said Dr Surana.

How does the capital gains tax apply in new regime?

Long-term capital gains (LTCG) above₹1.25 lakh from equity mutual funds are currently taxed at 12.5%. Short-term capital gains are taxed at 20%.

Further, the LTCG and STCG tax apply under the new tax regime even when the taxpayer's total income is below ₹12 lakh. This is because special rate incomes do not qualify for Section 87A rebate in the new regime.