‘Its all in the family’ It may seem ordinary to invest money for a non earning spouse by way of fixed deposits, or other income earning assets or to set up bank accounts, mutual funds or other investments for children to provide for their needs in future. Usually, you are only taxed for your own income, but under certain special circumstances some incomes are ‘clubbed’ along with your income and you may be liable to pay tax on such clubbed income.
The intention here is to make sure there is no tax that escapes, in case an individual is moving assets or incomes in the family. In a situation where you have incurred a loss, such loss (wherever allowed to be adjusted against an income) is also not allowed to be transferred to anyone and will be ‘clubbed’ to your income.
Let’s understand in what circumstances you may attract this ‘clubbing’ of income –
In the case of Assets Transfer to Anyone
Transfer of Income – no transfer of assets: When you retain the ownership of an asset but decide to transfer its income by doing an agreement or any other way, the Act will still consider that income as your income and it will be added to your total income for taxation purposes.
Transfer of Asset – which is revocable: When you transfer the ownership of an asset and make such transfer revocable, income from such an asset will continue to be added to your income.
Clubbing of Spouse’s Income
Here are some situations when your spouse’s income will get clubbed to your income and you’ll have to pay tax on it-
(1) Your spouse receives a salary from a company or a firm in which you have a substantial interest, then such salary will be clubbed with your income. Substantial Interest means you alone or with your relatives (husband, wife, brother, sister or your lineal ascendant or descendant) hold equity or voting power of a company which is 20% or more. Or in case of a firm you are entitled to 20% or more of the profits. Also, if both of your receive an income from such a firm or company, it will get taxed in the hands of the person whose taxable income is higher. There is one exception to this – if your spouse receives the salary due to his/her application of technical or professional knowledge & experience then such salary will be taxed in the hands of the person receiving it and not clubbed.
(2) You transfer an asset to your spouse directly or indirectly without receiving adequate consideration (does not include where asset is transferred as part of a divorce settlement) – income from this asset will be clubbed with your income. For example – where the husband to reduce his tax liability transfers an asset worth Rs 1,00,000 to his wife for Rs 25,000 .3/4th of the income from this asset will be taxed in the hands of the husband. If he receives no consideration, in that case the entire income from this asset will be clubbed with the husband’s income. Although the clubbing provisions here exclude house property – but in case you transfer a house property to your wife and do not receive adequate consideration, as per the Act, you will still be considered the ‘deemed owner’ and the income from the asset will be clubbed with your income.
(3) You transfer an asset to a person or an association of persons, directly or indirectly, without adequate consideration, so that the benefit arises to your spouse either now or on a deferred basis, income from such an asset will be clubbed with your income.
(4) Assume a situation where you provide money to your spouse (who is non working) and that money is invested by the spouse and a certain income is generated (from such money that you gave your spouse).The income that arises from such investment done by her can be clubbed to your income. However, if your spouse reinvests the income portion and earns further income then such income may not be clubbed with your taxable income.
Clubbing of Income of Minor Child (less than 18 years old)
(1) Some families make fixed deposits in the name of a minor child. Income of a minor is taxable in the hands of the parent whose total income is higher (before including the minor’s income). If the parents are divorced it is clubbed with the person who is maintaining the child. There is one exception to this rule – if the minor has earned an income because of his own manual work, or used his talent or specialized knowledge & experience OR in case of a minor who is disabled (based on definition of disability in Section 80U) and earns an income, such income will not be clubbed.
(2) When your minor child’s income is clubbed to your income – exemption is available up to Rs 1500 for each such minor child. Which means if clubbed income is more than Rs 1500, Rs 1500 is the maximum exemption, however if clubbed income is say Rs 800 (less than Rs 1500) exemption is limited up to such lesser amount, Rs 800 in this case.
Clubbing of Income of a Major Child (18 or more than 18 years old)
You may be giving over some money to your major child (who may not be earning), in this case if the major child invests that money – any income from these investments will not be taxable in your hands but will be taxed in the hands of the major child. So therefore, there will be no clubbing of income in case of a major child.
Clubbing of Income of a Son’s Wife
You transfer an asset to your son’s wife directly or indirectly without receiving adequate consideration – income from this asset will be clubbed with your income. Or you transfer an asset to a person or AOP, for the immediate or deferred benefit of your son’s wife, without adequate consideration, directly or indirectly – income from this asset will be clubbed with your income
What about Gifts
On one hand are the clubbing provisions that club income that you may be trying to move within family and there are some provisions that allow certain gifts. Even though Gift Tax Act was abolished effective 1st October 1998, certain provisions in the Income Tax Act can tax the money or assets you gift. In our next post we will look at what are the provisions that can tax the gifts that you may be giving or receiving. Keep watching out for more! And reach out to us if you have any queries.