By Amarpal S Chadha

As the financial landscape becomes increasingly intricate, it is imperative to refine wealth management strategies. Ensuring efficient distribution of income among family members while remaining aware of the tax implications that come with wealth sharing are essential.

Clubbing of income

One critical aspect of taxation is the concept of the “clubbing of income.” This provision ensures that when income-generating assets are transferred within a family (specified relationships like spouse, daughter in law, minor child, etc.,) the income from those assets is typically taxed in the hands of the transferor. The primary intent is to prevent the shifting of income to lower-income family members purely with an intention to avoid taxes.

Exceptions

There are notable exceptions to these clubbing rules. Not every transfer of assets within a family will trigger the clubbing of income provisions. Assets transferred by an individual to his/her brother/sister or major son/daughter does not trigger the clubbing of income provisions.

One potential strategy for wealth creation while minimising tax impact is gifting assets to an adult child. For example, transferring or opening a fixed deposit in the child’s name can be a smart move. Not only does this secure the child’s future, but it can also serve as an effective tax strategy. Since the clubbing provision for interest income does not apply in this case, the interest earned can be used to offset educational or other expenses, thereby resulting in tax efficiency and wealth creation for the family.

Another scenario where clubbing of income does not apply is when assets are transferred as part of a divorce settlement. The income generated from these assets is not included in the original owner’s income.

When it comes to minor children, while their income is included in the higher-earning parent’s taxable income, an exemption of Rs 1,500 is allowed. If a minor child’s income is included in a parent’s taxable income, the parent is entitled to claim an exemption of Rs 1,500.

For example, if a minor child earns  Rs 6,000 from an investment, the parents’ taxable income will reflect only Rs 4,500 after application of the exemption, easing the tax burden.

While these legislative provisions may appear restrictive, they are not designed to impede financial growth. By understanding how legal frameworks treat revenue from family assets and ensuring equitable compensation for each family member’s contributions, families can effectively manage their wealth, minimize superfluous tax burdens, and maintain compliance. With careful planning, wealth can be structured efficiently, provided incomes subject to clubbing are properly disclosed and taxed in accordance with the law.

The writer is tax partner, EY India. Inputs from Shanmuga Prasad, director, EY India.

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