Clubbing of Income – Income Tax
Clubbing of Income – Income Tax
According to the stipulations of the Income Tax Act, a person has to pay taxes on all taxable income earned during a financial year. At the time of computing the Gross Total Income, if the income of any other person in a family is included, then the inclusion is called ‘Clubbing of Income’. Section 64 of the Income Tax Act, 1961 deals with clubbing of income. Clubbing of income ensures that taxpayers do not circumvent their tax liability by transferring their incomes and assets within the family. In this article, we briefly discuss the provisions relating to the concept of clubbing of income under the Act.
Clubbing of Income
As per the Income Tax Act, every person has to pay taxes on the taxable income earned. No person is allowed to divert his income to any relatives to reduce tax liability. Clubbing of income means an income of other person is included in the taxpayer’s total income while computing income tax payable.
Reason for Clubbing Income
Many taxpayers in India have attempted to reduce their income tax liability by transferring their incomes and assets to their family members, in such a way that most of the income falls under the taxable amount. The clubbing of income regulations ensures that such practices are curbed.
Examples for Clubbing of Income
Clubbing of income is needed under the following circumstance:
- Investing money in the form of a fixed deposit in children name.
- Earning assets in the name of relatives (wife or child).
- Creating saving bank accounts for dependants.
- Mutual funds for the child.
- Shares in the name of spouse/child.
- Post office savings for family members.
Also, if a taxpayer transfers the ownership of an asset and the income from the asset to a dependant, it will be continued to be added to the taxpayer’s income under the clubbing of income provisions. The following is an example for better understanding: If a person is purchasing a flat in the name of a family member and the other person let out this flat on rent, the rental income earned by the person in name of the family member is taxable. As per section 64 of Income Tax, the income would be clubbed with person purchasing the flat.
Clubbing of Income Rules
Clubbing of income relates to income from investments made on behalf of a spouse, minor child, spouse or daughter-in-law. These incomes are integrated together and taxed on the overall income. The following are some of the major rules relating to clubbing of income:
Transfer of income without transfer of asset
When a person retaining the ownership of an asset but transfers the income from the asset to any of his relatives by an agreement or any other way. – As per Section 64 of the Income Tax Act, such income will be taxable in the hands of the transferor.
The following explanation illustrates the concept of income transfer: Assume that person “A” owns 10000, 50% debentures of XYZ private limited of Rs. 500 each. But he is transferring the interest income to his family member “B” without transferring the ownership of Debentures. In this case, although interest will be received by a family member, it is taxable in the hands of “A”.
Revocable transfer of asset
If an asset is transferred under a revocable transfer, income from such asset is taxable in the hands of the transferor. For example, if a person “M” transfers his house to one of his friend N. And, M has right to revoke the transfer during the lifetime of N, then the income arising from the house property will be taxable in the hands of M.
Clubbing of Spouse Income
Clubbing of spouse income is the most common under Section 64 of the Income Tax Act. The following are some of the major aspects of clubbing of spouse income:
Remuneration to Spouse
A person’s income is to be clubbed with a spouse’s income if any payment is received from the spouse through the following methods:
- Salary or remuneration paid to spouse directly.
- Wage or remuneration or commission paid to spouse from a concern in which the assessee has a substantial interest.
For example, if Mithun has a substantial interest in a Company and his wife Anila is working in the company and she is not in any technical or professional qualification. – In this case, the salary income of Anila will be taxable in the hands of her husband Mithun. The key criteria are the technical or professional qualification of the spouse. Hence, clubbing of income would not be applicable, if the spouse possesses technical or professional qualification and income of the spouse is related with such technical or professional knowledge.
Income from Assets Transferred to Spouse
If an asset is transferred by a Person to his spouse directly or indirectly, any income from such asset will be considered as income of the transferor. However, the transfer must not be in connection with an agreement of divorce settlement or with adequate consideration. For example, if a flat is transferred by Arun to his wife Divya. Rental income on the flat will be considered as income of Arun. However, clubbing of income provisions will not be applicable if the transfer of the asset is made through an agreement of divorce or settlement or to live apart.
Income from assets transferred to son’s wife
Any income which arrives from the assets transferred directly or indirectly by an individual to his son’s wife, otherwise than for adequate consideration, would be included in the transferor income.
Income from assets transferred to benefit the spouse of the transferor
Where an individual transfers any assets to any person or association of persons, otherwise than for adequate consideration, the income from such assets would be included in the income of the transferor to the extent of benefit that accrues to the spouse, would be included in the total income of the individual.
Income from Minor Child
- Any income of the minor child is to clubbed with the parent whose income is higher. If the natural parent of a minor child parents does not exist, then in such cases, the income of minor would be taxable in the hand of the parent who maintains the minor child in the previous year. Also, the child would include both stepchild and adopted child.
- In case of death of both mother and father, the income earned by the minor cannot be clubbed and hence the minor child is required to file income tax return through his legal guardian.
- It must be noted that income once included in the total income of either of the parents would continue to be included in the hands of the same parent in the subsequent years, unless assessing officer is satisfied that it is necessary to do so, after giving that parent opportunity of being heard.
- Additionally, if a child attains majority during the previous year, then, part of the income earned by the child during his minor period would be clubbed in the hands of the parents.
- The parent with whom the income is clubbed will be allowed an amount of deduction from the total income amounting to Rs.1500 per minor child. Under Section 80U of Income Tax Act, clubbing is not to be done when income arises from manual work or application of his skill or specialized knowledge and experience of the minor child suffering from any disability. Such income which arises to the minor child on account of any manual work done by him. Such income which arises to the minor child on account of any activity involving the application of his skills, talent or specialised knowledge and experience.
- Finally, clubbing of income is applicable if a person transferred an asset without adequate consideration to son’s wife or daughter-in-law. Any income from such an asset would be considered as income of the transferor.
When Child’s Income does not qualify for Clubbing
In the following situations, minor child income will not be clubbed in the hand of the parent:
- Manual work is done by the minor.
- Activity involving the application of his skill, talent or specialized knowledge and experience.
- The child is suffering from any disability specified under section 80U.
Investment in Minors Name
The income of the minor, which is not clubbed in the hands of parents, if invested somewhere and income is earned from such investment, then, in such case, the income so earned from the investment would be clubbed in the hands of the parent. For example, if a child is an artist who has earned an income of INR 50,00,000/-. Since the income is earned by the child on the basis of his own skill, such income will not be clubbed in the hands of his parents. Further, INR 50,00,000/- earned by the child is invested in fixed deposit and interest of INR 50,000/- is earned out of such investment, then, interest income would be clubbed in the hands of the parents whose income is higher.
Income from Self-acquired Property Converted to Joint Property
If self-acquired property of an individual is converted into joint famil property without the adequate consideration, then the income derived by the joint family on account of such property would be included in the total income derived by the joint family on account of such self-acquired property.
Where an individual, who is a member of the Hindu Undivided Family (HUF) who,
- Converts, his separate property of the HUF, or
- Throws the property to the common stock of the family, or
- Transfers his individual property to the family,
otherwise than for adequate consideration, then the income from such property would be included in the total income of the individual.
Implication in cases of Subsequent Partition
Where the property converted has been the subject matter of the partition amongst the family members, the income derived from such, converted property is received by the spouse, on a partition would be deemed to arise to the spouse from the assets transferred indirectly by the individual to the spouse and the income from the portion, that is received by the spouse, would be clubbed in the hands of the transferor. Although the income from an asset held by the assessee is transferred to certain specified persons under the clubbing of income provisions and hence is includible in the transferor total income, yet the Act that provides the notice of demand in respect of tax on such income that would also be served upon the person to whom such asset has been transferred. On service of such notice, the transferee would be liable to pay the portion of the tax levied on the transferor that is attributable to the income included.