When your income tax is mounting every year, what is the first tax-saving idea that comes to mind? Transferring a part of your income to spouse or a minor child who has a meagre or no taxable income? But that may not be a great idea.
You may revel in the thought of coming up with this brilliant idea, but the taxman is one step ahead on this one too. The income tax laws provide for ‘clubbing of income’ of spouse and minor child in certain cases, with your taxable income and taxing such income as if it was your income.
Such provisions were necessary to curb tax avoidance by individuals who transferred their income or income-generating asset directly or indirectly to other family members, especially spouse, minor child and daughter-in-law.
Any income arising to your spouse or daughter-in-law from an asset transferred to him/her without adequate consideration will be clubbed in your hands. For instance, the rent received by your wife from a house property you gifted her will be taxed as your rental income. This provision, however, will not apply if the assets are transferred with an agreement to live apart.
Clubbing provisions apply not only to direct transfers to the spouse or son’s wife, but also attract tax in case of indirect transfer of assets for the benefit of the spouse or son’s wife. An asset transferred to a third person, without adequate consideration, for the benefit of your spouse or son’s wife also falls within the purview of the clubbing provisions.
Another common way of transferring income to the spouse is by paying him/her salary or commission or fees and reducing it from the taxable income from business or profession in which the individual has substantial interest (as defined in the Income Tax Act). The income tax laws contain provisions to deal with such cases too. Any income (salary and commission) arising to the spouse from any concern, be it a proprietorship concern, partnership firm or company in which the individual has substantial interest, will be clubbed in the hands of the individual and will be taxed accordingly. However, in cases where the spouse possesses technical or professional qualification, and the income is attributable to the application of such technical or professional knowledge and experience, clubbing provisions do not apply.
It is common for parents to invest in assets or term deposits in the names of minor child. The tax laws provide that the income from such investments, even though received in the name of the minor children, is to be clubbed in the hands of either of the parent whose total income is greater. Such clubbing of income in the hands of the parents will continue every year unless the tax official, after giving an opportunity of being heard, finds it necessary to club it in the hands of the other parent.
Meagre relief in the form of an ad hoc exemption of up to R1,500 per child is available to the parent for each child whose income is clubbed by the parent. An exception would be if the minor child has earned the income by way of manual work done by him / her or on account of his/her skills, talent or specialised knowledge and experience. For instance, income earned by a minor artiste from acting in a TV show or movie will not be clubbed in his/her parent’s hands.
The clubbed income is taxed under the same head under which it is sourced (interest income earned by a minor or the spouse will be clubbed under income from other sources, rental income will be taxed as income from house property and so on).
Exempt income such as interest received on PPF, clubbed in your hands will be exempt. The provisions apply to non-resident tax payers just as they apply to resident tax payers. Thus, a non-resident may be taxed in India on the income earned by his minor child or spouse in India as explained above, even if he has no other taxable income of his own.
Therefore, transferring taxable income to the spouse or minor child or daughter-in-law is not a great idea and may not yield tax-saving benefits.
By Mousami Nagarsenkar
The writer is senior manager with Deloitte Haskins & Sells LLP. With inputs from Bhavin Rajput, manager, Deloitte Haskins & Sells LLP. The views are personal.