Grandparents gift ₹5 lakh to your child? Here's who pays tax on FD interest and mutual fund gains

On Children's Day, grandparents often gift money to their grandchildren to support their education, future expenses or long-term financial security. While such gifts may be exempt from income tax, investing the money in fixed deposits (FDs), mutual funds or other financial instruments can create tax obligations for the child's parents.

Under India's income-tax rules, gifts received from specified relatives, including grandparents, are generally exempt from tax, irrespective of the amount. However, the income generated from investing these gifts is subject to separate taxation provisions.

What happens when grandparents gift ₹5 lakh?

Suppose grandparents gift ₹5 lakh to their 10-year-old grandchild. Since grandparents qualify as specified relatives under income-tax provisions, the entire gift is exempt from tax.

However, if the money is invested in an FD offering 7% annual interest, it would generate ₹35,000 in interest over one year.

This interest is generally clubbed with the income of the parent whose total income is higher before including the minor's income. Consequently, the parent may have to pay tax on the interest according to their applicable income-tax slab.

The same principle applies to dividends and taxable capital gains arising from mutual funds purchased using the gifted money.

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What are the income-tax clubbing rules?

Section 64(1A) of the Income-tax Act, 1961, provides for clubbing a minor child's income with that of a parent. The corresponding provision under the Income-tax Act, 2025, is Section 99(1)(c).

Where parents are separated, the income is generally clubbed with that of the parent maintaining the child.

Under the old tax regime, parents can claim an exemption of up to ₹1,500 annually per minor child against clubbed income. This exemption is unavailable under the default new tax regime.

However, income earned by a child through personal skills, talent or manual work is generally excluded from clubbing provisions.

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What if the gift comes from friends or non-relatives?

The tax treatment changes when money comes from individuals who do not qualify as specified relatives.

If monetary gifts received from non-relatives exceed ₹50,000 in aggregate during a financial year, the entire amount becomes taxable, subject to applicable exemptions.

For example, if a child receives ₹60,000 from family friends, the full ₹60,000 may become taxable rather than only the ₹10,000 exceeding the threshold.

How can parents avoid tax complications?

Parents should maintain gift declarations, bank transfer records and investment statements to establish the source and ownership of funds.

They must also report taxable interest, dividends and capital gains correctly in their income-tax returns.

The key distinction is that a tax-free gift does not automatically mean tax-free investment returns. Understanding this difference can help families build wealth for children without unexpected tax liabilities.

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