Gifting mutual fund units — to relatives and to others

Section 56(2)(x) of the Income Tax Act taxes most gifts above ₹50,000 received during a financial year, with a carve-out for transfers to defined "relatives" and to certain other categories like inheritance, marriage gifts, and transfers under a will. Mutual fund units, like cash or property, fall under this section. Knowing exactly who counts as a relative for this purpose is the difference between a tax-free transfer and a taxable one.

Who counts as a relative

The Income Tax Act defines relatives precisely. For a gift to a resident individual recipient, "relative" means:

• Spouse.
• Brother or sister.
• Brother or sister of the spouse.
• Brother or sister of either parent.
• Lineal ascendant or descendant (parents, grandparents, children, grandchildren).
• Lineal ascendant or descendant of the spouse.
• Spouse of any of the above relatives.

Notably excluded: cousins, nieces, nephews, in-laws beyond the listed categories, friends, employees, business associates. A gift of mutual fund units worth ₹10 lakh to a cousin is taxable to the cousin at their slab rate on the full ₹10 lakh.

Cost basis inherits to the recipient

When the recipient eventually sells the gifted units, capital gains are computed using:

• Cost of acquisition: what the donor originally paid.
• Date of acquisition: the donor's original purchase date.

This is the same treatment as inheritance. The cost basis does not step up to the gift-date NAV; the recipient absorbs the donor's tax liability on the accumulated gain.

The income clubbing trap (Section 64)

One critical wrinkle: if you gift mutual fund units to your spouse, your minor child, or your son's wife (daughter-in-law), the income arising from those units gets clubbed back into your taxable income under Section 64. The recipient is the legal owner; you pay the tax.

Capital gains and dividends from the gifted units fall under the clubbing rule. This significantly reduces the effectiveness of using gifting as a tax-saving lever for one's spouse. A common alternative: gift to adult children (who are not subject to clubbing) instead.

If the recipient invests the gift income further and earns secondary income from that re-investment, the secondary income is the recipient's — not clubbed back to the donor. This is sometimes used in long-horizon estate planning.

How to gift mutual fund units

Two operational options:

1. Off-market transfer of demat-held units: if the donor holds mutual fund units in a demat account, an off-market transfer slip moves them to the recipient's demat account. KYC for both parties is needed.
2. Redeem and re-buy: the donor redeems the units, transfers cash to the recipient's bank account, and the recipient buys fresh units in their own name. This triggers capital gains on the donor's sale (and a new cost basis for the recipient's new purchase). For relatives where the goal is wealth transfer and the donor has unrealised gains, this is usually the cleaner path despite the upfront tax.

For folio-held (non-demat) mutual fund units, in-specie transfer is not commonly supported by AMCs — most require redemption and re-purchase.

Marriage gifts

Section 56(2)(x) carves out an explicit exemption for gifts received "on the occasion of marriage" of the recipient. Wedding gifts of mutual fund units are tax-free regardless of relationship or value. The receipt must be at the marriage occasion — a year later gift on the same person's birthday does not qualify.

Documentation

For a tax-free relative gift, no formal deed is required, but you should document the transaction. A simple gift deed mentioning the parties, relationship, units transferred (folio, scheme, ISIN, units), and the date is enough. Keep this with your tax records for at least 8 years (the loss-carry-forward window) — the Income Tax Department can ask for proof at any subsequent assessment.

Practical use cases

• Parents gifting MF units to adult children for goal funding (no clubbing, no tax).
• Adult children gifting to elderly parents for SWP-based income (no clubbing back to children since reverse direction is not specified).
• Distributing legacy among multiple relatives through gifting during one's lifetime instead of through a will.
• Cross-spouse transfers to balance who owns what — though clubbing nullifies the tax benefit.