Priyansh Sata and Hiya Thawani’s innovation for a 'Schoolprenuer' summit helped them start an apparel business amidst the lockdown blues. These high-school kids won the fourth place in the competition. They also established a brand on a leading e-commerce platform.
But Sata didn’t earn anything out of the whole experience as it was an internship initiative. However, the amount he won from the competition would be under the income tax lens. Apart from competitions, children today are running businesses in different forms at the age of 11-16.
Not all income earned by children is taxed as their own. This is because there is a blurring line between income of parents being disguised as child’s income to avoid taxes and the income being earned by the child.
Let us understand how parents must distinguish between the two and avoid tax evasion notices from the income tax department.
Clubbing of income through investments
In a normal scenario, the income of the child or earnings on the investment of the child is clubbed with the income of the highest earning parent and taxed accordingly. So, if Priyansh’s mother had been the higher earning parent, then the amount won through the competition should have been added to her income and taxed.
“Any money won in competitions, events such as Indian Idol, Kaun Banega Crorepati is subject to tax deduction at source and is taxed at a flat rate of 30 percent irrespective of your slab rate,” says Sudhir Kaushik, cofounder of TaxSpanner.com.
Similarly, the interest that is earned on the money won in the competition, too, is added to the parent’s income. So, any investment made in the child’s name that is earning interest or returns would be added to the parent’s income.
“If you purchase a property in the name of the child and you earn rent from the same, then the rent too is clubbed with the parent’s income,” says Kaushik.
Business income of the child
Clubbing could lead to a high tax burden on the parent. It also has the potential to shift the parent’s tax slab from 10-20 percent to the highest slab.
So, if your child has been running a business and earning money through the initiative, then it makes sense to file a separate income tax return for the kid. “For one-off events such as a competition, parents should use the clubbing of income provisions. But if they can prove that the child himself has earned money by demonstrating his own capabilities and knowledge and come up with the business idea, then a separate income tax return should be filed,” suggests chartered accountant Mehul Sheth.
“Sachin Tendulkar first started earning when he was 16 years and he was using his own talent. Under such circumstances, his income cannot be clubbed with the highest earning parent,” adds Sheth.
So, while for owning a bank account or purchasing a term life insurance you need to be above 18, there is no such restriction while filing an income tax return. “Age is not a bar under Income Tax Act and hence even a minor child can get a PAN and file his own return if he is earning through his own creativity or talent,” says Kaushik.
Benefits of filing returns
Under income tax provisions, children too are judicial persons and deserve to get the same tax-saving benefits that adults enjoy. “To claim the tax-savings benefits such as tax-free income of up to Rs 2.5 lakh, benefit of health insurance, tax-saving investments can all be claimed only when they file income tax returns,” Kaushik says.
So, if the child is earning above Rs 2.5 lakh, then he is above the basic threshold limit and would have to file an income tax return. All the tax slabs applicable to adults are same for the child too. It is critical that the income earned by the child to be declared, as it is considered the responsibility of parents and a penalty would be applicable if the income is undeclared.
“Once the income is declared, then parents also have the option of investing their capital gains in a start-up of their child and claiming taxation benefits under Section 54GB,” says Kaushik.
Initial Funding
When young children initiate their own ventures, they often use the funding from parents for the initial years. Child entrepreneurs Inaya Bassi (12) and Kashvi Shah (13) have been maintaining excel sheets to note down the amount they have used for their food and perfume business.
“Through the money I earned in the initial days, I made sure that I returned the initial capital to my father,” says Shah. Now such money that has been invested by parents can be taken on the books as a loan for the business, say experts.
“The child can take a business loan for funding the business from parents or anyone else. But this loan has to be returned to the parent or the funding entity after the child turns 18. An interest of the State Bank of India FD rate is applicable on the loan taken until it is returned,” says Kaushik.
Alternatively, the child can also offer equity (in the business) to the parents in return for their funds.
Check other compliance matters
But when you file a tax return to claim your own tax benefits, there are other responsibilities you need to fulfil. See if the business needs license and comes under other taxation aspects such as GST.
“If a flourishing business has been established by a child such as by Tilak Mehta, who founded a logistics firm Papers N Parcels in association with the dabbawalas, then you can set up a proprietorship firm and also check for GST compliance for turnover exceeding Rs 20 lakh apart from filing an income tax return in the name of your child,” says Sheth.
