The Income Tax Act of 1961 governs income tax in India and provides a systematic framework for the assessment, computation, and realisation of tax from different income sources. This Act divides income into five distinct heads, thus ensuring detailed coverage of all earning possibilities. These are: Income from Salary, Income from House Property, Profits and Gains of Business or Profession, Capital Gains, and Income from Other Sources.
Every category has provisions dealing in depth with computation, deductions, and exemptions. Such classification allows for accurate income assessment and ensures taxpayers are taxed fairly based on the nature and source of their income. The Act also outlines applicable tax rates, income tax filing procedures, and compliance requirements for individuals, partnerships, corporations, and other entities. Briefly, these categories of income are central to the Indian tax system, promoting transparency and consistency in the administration of direct taxes.
What is Clubbing of Income?
Clubbing of income is a provision provided by the Income Tax Act of 1961 with a view to checking tax evasion by passing on income or assets to close relatives. The ruling states that some incomes earned by another person are clubbed (or aggregated) with the income of the assessee and taxed accordingly. Sections 60 to 64 of the Act contain the major rules pertaining to clubbing. Such provisions hold when a taxpayer transfers income or property to some other individual, commonly, a spouse, minor child, or daughter-in-law, without proper reimbursement, with a view to reducing their taxable income. The clubbing provisions aim to encourage tax fairness and to stop exploitation of technicalities in law to achieve income sharing and reduction of tax. Accordingly, the initial owner is still liable for the tax burden, thus maintaining the sanctity of the tax system.
Who Can Club Income?
Under the Income Tax Act of 1961, the principle of income clubbing refers to the inclusion of income received by another person in the taxable income of the assessee (the person who is to pay tax) under certain conditions. This step is taken to prevent tax evasion that could result from the transmission of income or assets to relatives or third parties without suitable remuneration.
Clubbing is only applicable to specified relationships, and the onus of reporting it lies with the transferor, the person who transfers the asset or income. Even if the income is lodged against the name of the transferee, it is not taxed if the clubbing provisions exist. An individual assessee is liable for income clubbing if they transfer income and assets to close relatives with less than satisfactory consideration or through revocable arrangements. The burden of tax rests on the transferor and not the recipient, with an aim to fairly tax and avoid splitting income artificially to lower tax charges.
Individual Assessee – The Key Individual Subject to Income Clubbing:
By law, some individuals are compelled to club their income under certain conditions:
- Spouse: If a person transfers an asset or income to his/her spouse without receiving adequate compensation (Section 64(1)(iv)), the income will be clubbed with the income of the transferor. Section 64(1)(ii) would also apply in case the spouse gains from a business in which the assessee has a significant interest.
- Minor Child: According to Section 64(1A), the income of a minor child is joined with the income of the parent with higher aggregate income, not including income from employment through manual labor or talent based activities. One exemption of ₹1,500 is available for each child. This clause doesn’t extend to handicapped young children as defined under Section 80U.
- Daughter-in-law (wife of the son): As per Section 64(1)(vi), in the event of an asset being transferred to a wife of a son without sufficient consideration, income arising on such asset is brought into the income of the transferor.
- Daughter-In-Law (Receiving indirect benefit): Where a daughter-in-law indirectly profits from a company in which the assessee has a significant interest, the income can be lumped together with that of the transferor.
- Transferee of Revocable Transfer: Where a person makes a transfer of property that is revocable (according to Section 61), the income derived from the property continues to be assessable to the transferor.
- Transfer without Ownership (Section 60): Transfer of income without the actual ownership of the property results in the transferor’s tax liability.
Who Cannot Club Income?
It should be remembered that income cannot be accumulated by Hindu Undivided Families (HUFs), partnerships, or companies undertaking transfers under such provisions. Furthermore, the above provision does not apply to transactions between siblings, parents, or acquaintances unless an express provision is called upon.
When and How is Income Clubbed?
Sections 60 to 64 of the Income Tax Act, 1961, introduced the concept of clubbing of income with a view to preventing tax evasion by transferring income or assets into close relations or other businesses. Clubbing means that income generated by some other person can be brought into the hands of the transferor, subject to certain circumstances.
Income is clubbed where income is lawfully transferred but the transferor family members or themselves actually control or enjoy it. The Income Tax Act, 1961 ensures that such schemes do not lead to tax benefits that are not justified, maintaining the integrity of the tax regime. Taxpayers need to be quite careful in their relationship with funds to avoid violating clubbing provisions.
When is Income Clubbed?
Income is clubbed when a taxpayer
- distributes income or assets without reasonable regard to a particular connection,
- such transfer is made to specified relatives for example, a spouse, minor child, or son’s wife, and
- The transferor has some degree of control or benefit from the asset/income.
Clubbing usually takes place in the same financial year as the income of the transferred asset or arrangement. It may go on as long as there are stipulated conditions, for example, a transfer that is revocable or an asset in the hands of the transferee.
How is Income Clubbed?
1. Section 60 – Transfer of Income Without Transfer of Asset
If only the income from an asset (not the asset) is transferred, the transferor is taxed.
For instance, Mr. A can give his brother the rental income from his property but retain ownership. The rent is still taxable in the hands of Mr. A.
2. Section 61: Revocable Transfer of Assets
When there is transfer of an asset on a revocable agreement, income of the transferee is aggregated with his own. The transferor can at any time reverse the transfer.
3. Section 64(1)(ii) – Spouse’s Income from a Concern
Where a spouse of a person receives compensation (salary, fee, etc.) from an interest in a concern in which the person has a large interest, it is considered the income of the person, unless the spouse receives payment for technical/professional skills.
4. Section 64(1)(iv) – Transfer to Spouse
The income accruing on a property transferred to a spouse for insufficient consideration is added to the income of the transferor. This exception is not applicable if the transfer is in settlement of the divorce.
5. Section 64(1)(vi) – Transfer to Son’s Wife
Where an asset is transferred to a son’s wife in exchange for unacceptable consideration, the income of the asset forms part of the income of the transferor.
6. Section 64(1)(vii) – Transfer for Immediate or Deferred Benefit to Spouse
If an asset is transferred to any person for the benefit of the spouse, the income is clubbed with the transferor.
7. Section 64(1)(viii) – Transfer for Immediate or Deferred Benefit to Son’s Wife
Similar to above, if an asset is transferred for the benefit of the son’s wife, the income is clubbed with the transferor.
8. Section 64(1A) – Income of Minor Child
The income of a minor is aggregated with the income of the higher-income parent, except:
- The minor earns income from manual labor or expertise/special talent, or
- The child has a disability as per Section 80U.
- There is an exemption of ₹1,500 per child.
Important Points for Income Clubbing
- The shifting of income or assets to a spouse without sufficient consideration will affect the transferor’s income.
- Income transferred to the wife of a son: When one transfers an asset or income to his son’s wife (daughter-in-law) without fair compensation, the income will be added to the transferor’s income.
- Income of a minor child: A minor child’s income (except for personal talent or disability benefits) is combined with the parent’s overall income.
- Income from a revocable asset transfer: If an asset is transferred under a revocable agreement and the transferor has the right to take it back, the income continues to be taxable to the transferor.
- The shifting of income without the shifting of the asset: When the transferor shifts only the revenue and keeps the asset, he will become taxable on the revenue.
- Earning by spouse from a business in which the other spouse has a large interest: In the case where one spouse earns income from a business or organisation in which the other spouse has a major interest, such income is included in the income of the spouse who has the major interest, unless it is attributable to the earning spouse’s qualifications or skill.
How Can Clubbing of Income be Avoided?
By following these legal provisions, a person can efficiently reduce tax payments without violating the Income Tax Act of 1961.
- Avoid clubbing by making sure that property or income is passed for fair consideration.
- Pass property before marriage to avoid clubbing rules.
- Avoid retaining control or the right to revoke because income from irrevocable transfers is not clubbed.
- Where a spouse or minor child uses their own income or savings, clubbing does not occur.
- Income earned under personal talents or disabilities of a minor under Section 80U is exempt from clubbing.
- Ensure maintenance of proper legal documents and records to prevent tax evasion.
Conclusion
Provisions of the Income Tax Act of 1961 on clubbing of income are also intended to avoid tax evasion by limiting the indirect transfer of assets or income to relatives. Taxes imposed on the original transferee ensure that the tax system is fair and consistent. It is necessary for taxpayers to be aware of these regulations and also plan their financial transactions accordingly. While real transfers and autonomous income are permitted, artificial transactions entered into solely to reduce tax burdens can trigger clubbing rules. Prudent planning and compliance with statutory requirements are essential for effective income and tax management.
Related Services
