PFP Primer: Clubbing of Income

Have you ever created a fixed deposit in the name of your spouse thinking that interest income will be taxed as your wife’s income?

For instance, you are in 30% tax bracket while your spouse is in 10% tax bracket. You want to open a fixed deposit. Interest from fixed deposits is taxed at the marginal income tax rate of the depositor. You transfer (gift) money to your spouse and he/she creates a fixed deposit. Interest from such fixed deposit will be taxed at your spouse marginal income tax rate (10%) and tax outgo will be lower. Had you created the same fixed deposit in your name, you would have paid tax at 30%.

Don’t get excited.

Income Tax Department has made provisions under Sections 60 to 64 so that you can’t avoid paying taxes just by transferring assets to your spouse (or relative) who earns less. In the above example, you have transferred money to your spouse’s account (or invested in your wife’s name) just to save on taxes. You retain full control of the asset (almost). This is not acceptable to Income Tax Authorities.

Through clubbing provisions, income tax department wants to curb tax evasion through transfer of assets or income to those in lower income tax bracket.

In this post, I will discuss how and when clubbing provisions apply.

Transfer to Spouse or Investing in the name of Spouse

Your spouse gets salary, commission, fees or remuneration (in cash or concern) from any entity where you have substantial interest.  Such income of your spouse will be clubbed with your income. However, if your spouse possesses technical or professional qualification to justify such income, such income will not be clubbed with your income.

You own a substantial interest in an entity if you hold 20% ownership in the entity. Even holding by a relative shall be considered for the purpose.  Relative shall be as per Section 2(41) of the Income Tax Act. Relative includes spouse, siblings or any linear ascendants or descendants.

If you transfer any assets to your spouse without any adequate compensation, then income from such assets shall also be clubbed with your income.

Clubbing provisions shall also apply when you transfer assets to a person or association of persons (directly or indirectly) where the income from such assets is for immediate or deferred benefit of your spouse.

Additionally, as per Section 27(i) of the Income Tax Act, if you transfer a house property to your spouse or minor child without adequate consideration, you are deemed owner of the property. Hence, any rental income from such property or capital gains from sale of such property will be considered your income/capital gains.

An exception is when you transfer house property to your spouse under an agreement to live apart. In such a case, income/capital gains from such property will be your spouse’s.

Please understand clubbing works both ways. Clubbing provisions can be invoked in both cases:

1. When husband transfers assets to wife
2. When wife transfers assets to husband

Is there any case where transfer of assets to spouse won’t invoke clubbing provisions?

Clubbing provisions in transfer to spouse won’t apply:

1. If the transfer of asset to the spouse is for adequate compensation
2. If the transfer of asset to the spouse is in connection with an agreement to live apart
3. If the transfer of asset is done before marriage (to would-be-spouse or fiancée), no income shall be clubbed even after marriage. This is because the relation of husband and wife does not exist at the time of transfer of asset.

Such transfer before marriage may be considered a gift under Section 56 and taxed in the hands of recipient (since the recipient is not your spouse yet). However, such transfers (or gifts) at the time of marriage are exempt from income tax.

4. If the relation of husband and wife does not exist at the time of accrual of income (husband and wife have separated), there shall be no clubbing of income.

Essentially, the relation of husband and wife should exist both at the time of transfer of asset and accrual of income before clubbing provisions can be applied.

Transfer of Assets to Son’s Wife or Investing in the name of Son’s wife

If you transfer any assets to your son’s wife without adequate consideration, then income from such assets will be clubbed with your income.

Alternatively, if your spouse transfers the assets to your son’s wife and clubbing provisions are invoked, then the income from such asset will be clubbed with your spouse’s income.

Clubbing provisions shall also apply when you (or your spouse) transfer assets to a person or association of persons (directly or indirectly) where the income from such assets is for immediate or deferred benefit of your son’s wife (daughter-in-law).

What about Minor Children?

Income of the minor is clubbed with income of the parent, whose income is higher.

Income of the minor child on account of his/her skill, talent, knowledge, experience will not be clubbed with income of the parent. However, if this income is invested and returns earned (interest or in many other manner), such income shall again be clubbed with income of the parent.

If the parents have separated, the income will be clubbed with the income of the parent who maintains the minor child.

As a parent, you can claim deduction of Rs 1,500 per financial year per child under Section 10(32) for minor’s income clubbed with your income. If such income is less than Rs 1,500, you can take deduction for the entire income clubbed.

If your child is suffering from any disability specified in Section 80U of the Income Tax, then the income of such minor (from any source) is not clubbed with income of the parent. Hence, you can transfer assets (money, bonds, stocks, property etc) to such child and income from such assets will not be clubbed with your income.

Will the income be clubbed if I transfer to my major children?

No, the income can be clubbed only in case of transfer to spouse, minor children and son’s wife. If you transfer assets to your major children, income from such assets will not be clubbed with your income.

Such transfer of assets will also not be taxed under Section 56 of the Income Tax Act.

What if I transfer assets to my parents?

You can transfer (gift) assets to your parents. The income from those assets will be considered income of your parents and will not be clubbed with your income.

Such transfer of assets will also not be taxed under Section 56 of the Income Tax Act.

What about transfer to daughter’s husband?

There shall be no clubbing of income in such a case.

I know it sounds a bit bizarre. Income from assets transferred to daughter-in-law can be clubbed but income from assets transferred to son-in-law cannot be clubbed.

Such transfer of assets will also not be taxed under Section 56 of the Income Tax Act.

Transfer of Assets to persons other than relatives

Do note transfer of asset to any person (who is not a relative as per Section 56(2) of the Income Tax Act) without adequate consideration will be taxed in the hands of the recipient. There are a few exceptions for transfers (gifts) at the time of marriage of the recipient, money or property received through inheritance or through will etc.

And I am not talking about clubbing of income from gifted assets. I am talking about tax on transfer of assets. So, if you gift Rs 5 lacs to a friend, this amount will be added to your friend’s income and taxed accordingly.  The amount in excess of Rs 50,000 per financial year is taxed. Please note you will not have to pay any tax. Your friend will have to.

As per Section 56(2) of the Income Tax Act, relatives includes spouse, siblings (and their spouse) of self and spouse, siblings (and their spouse) of parents, linear ascendants and descendants (and their spouse) of self and spouse.

Please note even though the transfer of assets (gift) may be exempt from tax under Section 56, clubbing provisions under Section 60 to 64 may still apply on income from such transferred assets.

Let’s consider a few examples.

Case I

You gift a property to your son’s wife (daughter in law) which she puts out on rent. Since your daughter in law is a relative (under Section 56 of the Income Tax Act), there is no tax on transfer of such property to your daughter in law. However, income from such property will be clubbed with your income (as per Section 64) and taxed accordingly. So, transfer is not taxed but the income is clubbed.

Case 2

You gift a property to a friend (without consideration). Since your friend is not a specified relative (under Section 56), he will have to pay tax on stamp duty value (in excess of Rs 50,000) of the house. So, stamp duty value of the property will be added to your friend’s income and taxed accordingly.

However, clubbing provisions will not be invoked since the transfer is not revocable. Income from such property will not be taxed with your income. Transfer is taxed but the income is not clubbed.

Case 3

You gift a property to your major son (or daughter or parents) which he puts out on rent. Since your son is a relative (under Section 56 of the Income Tax Act), there is no tax on transfer of such property to your son. However, income from such property will not be clubbed with your income (as per Section 64) and taxed accordingly. So, neither transfer is taxed, nor income is clubbed.

Case 4

You invested in debt mutual funds in the name of your daughter when she was 15. You redeemed those units after she turned 18.  Transfer (gifts) to children is exempt under Section 56.

For clubbing provisions to apply, the relationship (spouse, son’s wife or minor children) should apply both at the time of transfer of assets and the time of accrual of income.

Since your daughter has become major at the time of redemption, such capital gains from the sale of MF units will not be clubbed with your income.

I offered a loan to my spouse, which she used to purchase an asset

If you loan money to your wife that she uses to purchase assets, then income from such assets won’t be clubbed with your income.  You loan Rs 20 lacs to your wife. She uses the funds to purchase a property. She puts that property on rent and uses rent to pay back the loan. Acceptable.

However, you must sign a loan agreement and charge a reasonable rate of interest to your spouse.

If you loan money without any interest, it can be considered indirect transfer to spouse and the rent will be clubbed with your income.

Income Tax Authorities will not take kind view of such transactions. Hence, you must have proper documentation (and transaction trail) ready.

Additional Rules (beyond Section 64)

Transfer of income to Anyone without transfer of Assets (Section 60)

If you transfer income from any of the assets without transferring the ownership of asset to the other person, then the income from such asset will be considered you income.

For instance, if you merely arrange to get the rental income from one of your properties to be credited to your friend’s bank account, such income shall be clubbed with your income and taxed in your hands.

So, essentially you own the asset but have merely transferred the income to your friend. This will attract clubbing provisions under Section 60.

Revocable Transfer of Asset to Anyone (Section 61)

You transfer the asset to someone. However, you retain the right to re-acquire the asset anytime during the lifetime of transferee (recipient) i.e. the transfer is revocable.  Income from such asset will be clubbed with your income.

Clubbing provisions do not apply if you transfer the asset by way of trust which is not revocable during life time of the beneficiary or when the transfer is not revocable during lifetime of the transferee (recipient).

Points to Note

1. For the clubbing provisions under Section 64 to be invoked, the relationship (spouse, son’s wife and minor child) should exit both at the time of transfer of asset and accrual of income. For instance, you invested in the name of your minor child in a debt mutual funds. However, your child has turned major at the time of redemption of units in such mutual funds. Capital gains from such sale won’t be clubbed with your income since the child is not minor any more.
2. Similarly if you had invested in the name of your spouse and the two of you separated thereafter (God forbid!!!), income from such investment won’t be clubbed with your income after separation.
3. Even loss (or negative income) is considered for clubbing.
4. If you transfer/gift money to your spouse, daughter-in-law or minor children and such money is invested in assets which yields tax-free income, your tax liability will not increase even if such income is clubbed with your income. For instance, your spouse invests in tax-free bonds, PPF and equity mutual funds. Interest is tax-free in case of PPF and tax-free bonds. Long term capital gains on equity mutual funds are also exempt from tax. Hence, no additional tax liability for you despite clubbing of income.
5. Income from re-invested savings is not considered for clubbing. This is not explicitly mentioned in the Income Tax Act but is based on judgements in courts. You can refer to this post on clubbing of Income for the exact case details. If you make a fixed deposit in the name of your spouse, interest income from that FD will be clubbed with your income. However, if your spouse use the interest amount to create another FD (say FD 2) or invests in equity shares, interest from FD2 or capital gains from sale of equity shares won’t be clubbed with your income.

 There are ways to save tax by forming a trust or HUF (Hindu Undivided Family) but I wouldn’t touch upon those aspects in this post.

Additional Read

Article on Clubbing of Income on TaxGuru

FAQs on clubbing of Income on Income Tax Website

Disclaimer: I am not a tax expert. This post is based on my interpretation of Section 56 and Sections 60 to 64. This post covers only a few common scenarios. Many aspects have not been covered to maintain readability of the post. This post is a primer. You must not base your decisions solely on the contents of this post. You are advised to consult a Chartered Accountant.

Image Credit: The original image and information about usage rights can be downloaded from Pixabay.