Written in : May 1998

Here is a story that you will find interesting, and perhaps, educating

Kumaran of Palghat, Kerala, purchased a house property in three names - that of his wife and two minor children.

Before we proceed with the story, let us first discuss this business of purchasing property in others' names. Either you purchase a property, or your wife and children purchase the property. How can you purchase property in their names? If they are investing their money and purchasing property, you are not purchasing property in their names - even if you represented them while dealing with others. The only other meaning that perhaps puts some sense is that you invest money and the property is acquired in their names. If that is so, and you propose to do it, do understand the implications beforehand. They may be dangerous as this story will show.

Back to the story. Kumaran, as I said, purchased the property in three names. The entire amount was invested by him out of his own funds.

His tax officer got curious. On enquiry, Kumaran told him that he had given loans of Rs.40,000 each to his two minor children. And the minor children had purchased the property out of the advance made by him.

The tax officer said that the alleged loans were not really loans but gifts by Kumaran to his two minor children. He, therefore, charged Kumaran to gift tax on Rs.80,000.

Kumaran, of course, did not accept the charge and disputed it in appeal. After going up to the Tribunal the matter went to the High Court of Kerala.

The court dealt with a basic issue: can a father give a loan to his minor child? Let us look at the reasoning of the court and then understand the conclusion

A minor child is incompetent to contract in law. Law says that a minor child cannot enter into any agreement with any person. Being of an age in which he is unable to understand the implications of his actions, any promises made by him which would bind him for a future obligation is prohibited. Whenever a minor enters into an agreement with another person binding himself to do something, such an agreement is void, a nullity. Law will not enforce such an agreement.

However, in many situations the father of the child can contract on behalf of the minor. In such situations, the father is as a 'parent and natural guardian'. He represents the minor when dealing with other persons and can contract with third parties. For example, a minor can acquire property by paying consideration - through his guardian acting for him.

What happens when you sell your shares to yourself? Nothing, because you cannot do it. You need two persons for a transaction to be completed.

What happens when you give a loan to your minor child?

When you give a loan to your minor child, you are dealing with - yes, yourself. On the one hand are you; and on the other are you again representing your child as guardian.

What is a loan? It is a contract between two persons - the lender and the borrower. The agreement is that the lender makes an advance and the borrower undertakes an obligation to repay it.

So, when you lend to your minor child, you give money to yourself with an obligation that you will repay it to yourself. Funny? No, you are really dealing with yourself - in two capacities. As an individual and as a guardian.

Can this be done? What happens if you fail to repay the loan to yourself? Should, or would, you sue yourself in a court of law? Or will you file a police complaint against yourself? Absurd?

Now you know why two persons are essential to complete a contract

The court said that you can have two capacities. Or even more. Like you can represent a minor child, another minor child, a HUF, a trust etc.

But you cannot have two personalities. You cannot be two persons at the same time

We saw that a loan is a contract. And there must be at least two persons for a contract to be completed.

When you deal with yourself alone, even if in different capacities, there are no two persons. You are alone. The contract is not between two persons.

Hence, the court held, the contract of loan was void. A nullity. As if the contract never happened.

The court held that you cannot give a loan to yourself representing a minor child, and bind yourself to repay the amount to you. The contract was clearly unenforceable and law would ignore it.

The court said that the tax officer was right in saying that the loans given by Kumaran to his minor children were in reality gifts. Kumaran should pay gift tax on the gifts as demanded by the bright officer

It is not uncommon for us to find persons purchasing property in their family member's names. The danger of loans being treated as gifts, as we saw above, always exists. And you run the risk of paying huge (30%) gift tax on such loans! Beware.