Taxpayers often attempt to reduce their tax obligations and outlays by shifting assets and diversifying revenue sources into the names of spouses, parents, children, and family members. To act as a deterrent to tax avoidance, the Income Tax Act includes the provision for ‘clubbing of income’ specified under Sections 60-64.
Let us streamline and explain the essential clauses related to the clubbing of income, including instances where clubbing of income is not applicable, as well as the methods to avoid clubbing of income for spouses.
Understanding Clubbing of Income Under the Income Tax Act
The inclusion or addition of another person’s income, typically family members, to your own income constitutes a clubbing of income. However, Sections 60 -64 of the Income Tax Act stipulate the rules concerning income clubbing. Specific limitations are assigned to prevent such practices.
The income that gets added to your overall income is known as deemed income. The regulations under the clubbing of income restrict the diversion of income and transference of assets by an individual in their spouse’s name, whether expressly or indirectly, for inadequate consideration. These clubbing stipulations are enforceable only for individuals, and not for other taxpayers like companies or HUFs. The criteria of clubbing of earnings cover a host of investments, ranging from FDs, property, mutual funds, post office savings, and shares.
For instance, if your overall earnings are Rs 3,00,000, which includes a rental income of Rs 1,00,000 and a paycheck of Rs 2,00,000. You transfer the income from rent to your wife without transferring the ownership of the house to her name. In such a scenario, when computing tax, your net earnings liable for tax will be compiled at Rs. 3,00,000 and not Rs. 2,00,000. This is due to the clubbing of income stipulations laid down by the Income Tax Act.
Clubbing of Income: Basic Provisions
Some of the specific conditions where clubbing of income applies are detailed below.
Section 60: Transfer of Income without Asset Transference
When an individual engages in income shifting without transferring ownership of the asset that generates such income, the income will be taxable in the hands of the transferor of the asset.
Section 61: Revocable Transfer of an Asset
When there is a transfer of assets in such a way that permits the transferor to revoke or reclaim the assets at a later date and resume control over them, it is known as a Revocable Transfer. According to the clauses of the clubbing of income, when there is a revocable transfer of an asset, in that case, any income or gains derived from that asset shall be taxable in the hands of the person who transfers the asset or the transferor.
B transfers a house property to C. However, B retains the right to revoke the transfer during C’s lifetime. This revocable transfer calls for the income earned from the house property to be taxable in the hands of B.
Section 64(1) (ii), 64(1)(iv), 64(1)(vii): Clubbing of Income of Spouse
Any remuneration received by a spouse from a concern in which both have substantial interest, then the clubbing of remuneration of both will be in the hands of the spouse whose income, omitting such remuneration, is higher.
Here, “substantial interest” implies that you have the right to own 20% or more profit share in the firm or have a voting power stake of at least 20% if it’s a company at any point in time in the year.
Income from any asset transferred to your wife with no adequate consideration shall be taxable in your hands. However, the clubbing of income regulation will not be implemented if:
- Transference of assets has been done for insufficient consideration or,
- For the divorce requirement
- Transference was carried out before marriage.
In situations where the transferee spouse alters the nature or character of the transferred gift, which was not previously taxed by investing it in an income-generating source, the regulations under Section 64 (1)(iv) are invoked, resulting in income clubbing. For instance, if a husband gifts his wife Rs. 6,00,000 as a gift, it will not be taxable. But, when the wife makes use of it as an FD investment and starts accruing interest, the earned interest onthe FD will be taxable in the hands of the husband.
Asset Transference to a third person or AOP without consideration or not adequate consideration that finally benefits your spouse immediately or at a future date. Such a transfer will be treated as deploying assets to delay the gains from those assets to your spouse and will fall under the scope of the clubbing provisions.
Transfer of Income to Daughter-in-law
Stipulations under clubbing of income also occur when a transference of the asset has been effected in your daughter-in-law’s name with no proper consideration. In such an event, the income derived from that asset will be added and taxable in your hands.
Clubbing of Income Related to Minor Child
Any income that a minor child earns is clubbed in the hands of their parents, whose income is higher. There are exceptions where clubbing provisions do not apply if the proceeds are earned by a minor child using their skill or talent, such as when the child wins money on TV shows.
Ways to Avoid Clubbing of the Income of Husband and Wife
Here are some ways to steer clear of income clustering and maximize your tax savings.
- Gift money to your wife only before marriage, as any transfers made after marriage will be subject to the clubbing provisions. If you gift money to your spouse who later invests in PPF, in that case, you do not qualify for tax cuts, but instead, your money earns zero tax interest.
- Purchasing health insurance for your family assists in claiming a deduction under section 80D. Section 80D allows a deduction of Rs. 25,000 for an individual and their spouse and children, and Rs. 50,000 for senior citizens. You can claim these deductions if the overall limit is not in excess of Rs. 50,000. 80D deductions are permissible only if the total income of the family is not more than Rs. 50 lakh.
- Offer your wife a loan at lower interest rates since no official rules are applicable in such cases in terms of interest rates. Make sure it is well documented and the loan repayments are settled through banking channels. This transmits the tax liability to your wife, and no clubbing will occur. However, a careful analysis is necessary, taking into consideration all the relevant factors.
- Make investments through a co-owned or joint account. When creating a joint account, confirm that the primary holder is the one with the lower tax obligations. For joint holdings, the tax liability for interest income rests with the primary holder, which can be beneficial in helping you minimize your tax burden. Besides, the withdrawals will be considered as inherent parts of gifts to relatives, which do not incur any tax.
- If you transfer the house ownership to your wife’s name, then any future income emanating from rental income will not be taxable in your hands.
- Investing in PPF products belonging to the tax-saving category in your spouse’s or minor child’s name will keep your income tax-free, as the maturity returns of PPF do not entail any tax. Similar is the case with equity products. Additionally, the amount can be donated to your elderly parents, adult children, or spouses who have lower tax obligations and can allocate this amount towards a PPF to gain tax-exempt returns.
Conclusion
The rule of income clubbing prevents a person from remitting lower taxes by transferring their income to another person. This prevents tax evasion via income transfers of an arbitrary nature between spouses and provides a legal means to preserve the segregation of income. By ensuring proper documentation, eschewing gratuitous transfers, and diversifying sources of income, couples are able to stay within the parameters of the law and encourage long-term financial sustainability.
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