Clubbing

Adding another person’s income in your taxable income

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Introduction

Usually, the income of a person is taxable in his own hands but in certain circumstances, the income of one person is taxable in the hands of another person. This phenomenon is called ‘Clubbing of Income’ in the Income-tax Act.

Why clubbing of income is done?

In India, Income tax is levied on a slab system. These are considered to be progressive rates of tax, i.e., the rate of taxes goes up as income amount goes up. For instance, the income tax rates start from a minimum of 5% and it goes up to 30%. Every person paying high taxes wants to reduce his tax liability. They do this by entering into certain transactions with nil taxpaying or low tax paying family members, such as transferring an asset (say rented house) to his family members having nil income so that certain income (say rental income) is taxable in the hands of a family member. As a measure of reducing tax liability, people also arrange their sources of income in such a way that tax burden falls on others (generally close members), whereas the benefit of the income is derived by them.

For instance, a salaried person instead of getting fixed deposits in his name makes a deposit in her wife’s name as she does not have any other source of income. Had he not diverted his funds to wife, the interest income would have been charged in his own account.

In order to curb such practices of tax avoidance, clubbing of income [adding income of another person into your taxable income] is done.

When is clubbing of income done?

  1. Transfer of income without transfer of asset

When an individual retains the ownership of an asset but transfers the related income to any other person, the related income will be taxable in the hands of the actual owner. Such income will not be taxable in the hand of the person to whom such income is transferred.

For instance, A landlord has given a house property on rent and asks the tenant to deposit rent in the bank account of the landlord’s son. As per taxation laws, the rental income shall be clubbed with the income of landlord even if rent is received by his son because he has not transferred the ownership of the house to the person authorized to receive the rent.

  • Transfer of asset without transfer of income

If a seller transfers his property but still retains the rights to receive the income earned therefrom, the income so generated will be taxable in the hands of the seller. Such income will not be taxable in the hands of the buyer.

Example, Mr A transfer his house to his brother Mr B but retains the right to receive the rental income of such house. In this situation, rental income shall be clubbed with the income of Mr A as he has transferred the ownership of the house but retains the rights to recover the income.

  • Transfer of income as well as asset, but the owner has the right to recover

In certain situations, the income from property shall be clubbed with the income of the original owner even if he transfers his asset to any other person. Given below is an illustrative list of situations:

  • Transfer to trust:  Income from a property is clubbed with the income of seller if he transfers his property to a trust for benefit of another person and he retains the rights to revoke the transfer during the lifetime of such beneficiary.

Example 1, Father creates trust and transfers his commercial property to the trust for 10 years. The trust is obliged to use the rental income for education of his son. In this situation, whatever income the trust generates from this property shall be clubbed with the income of the owner/father.

Example 2, Father creates trust and transfers his commercial property to it. The trust is obliged to use the rental income to meet the medical expenses of his son who is suffering from autism. In this situation, income generated by the trust shall not be clubbed with the income of the owner/father if trust gets rights over the property until the beneficiary is alive.

  • Transfer with the right to recover: Income from an asset shall be clubbed with the income of seller if he transfers the assets to a person (related or unrelated) but retains the power to recover the asset or income therefrom during the lifetime of the buyer.

Example 1, Mr A gift his property to his brother Mr B for 10 years. In this situation, whatever income Mr B earns from this property, shall be clubbed with the income of Mr A.

Example 2, Mr A gift his property to his brother Mr B. However, he reserves the right to re-assume the property after the death of Mr B. In this situation, income earned by Mr B from this property shall not be clubbed with the income of Mr A.

  • Employing spouse and paying salary

To reduce the tax expense of an entity, owners show their spouse (wife or husband) as an employee in their own entity. Exorbitant salaries are paid to the spouses even when they don’t have basic qualification for the job they are being paid for. This practice is generally done to take benefit of exemption limits and lower slab rates for income up to Rs. 10 lakhs. In this situation, the salary paid to the spouse is taxed in the hands of the person employing the spouse. [Note: wife can employ husbands and vice-versa]

Conditions for clubbing the income as per the above requirements

Such clubbing of income is done if:

  1. Spouse of an Individual is employed with a concern;
  2. Individual along with his relatives holds more than 20% equity share or profit-sharing ratio of that concern;
  3. The spouse receives excessive remuneration from such concern without having any technical or professional knowledge or experience.

If both (husband and wife) have substantial interest as mentioned above and both are getting salary without possessing any technical or professional knowledge or experience then the income of spouse will be included in the income of person whose total income (without including such income) is higher.

‘Relative’ shall include all those persons who can provide tax-free gifts to a person. Click here to know about the meaning of ‘Relative’.

  • Income from Asset transferred to the spouse

The husband can transfer an asset to his wife or vice-versa without any restriction. However, if transferee earns income from such asset, it shall be clubbed with the income of transferor while computing the income-tax.

This clubbing of income is done only if the taxpayer transfers his asset to the spouse (wife or husband) for inadequate consideration. Such clubbing of income is not done if an asset is transferred as part of alimony given to spouse on getting divorced or the asset was transferred for an adequate payment from the other person.

For instance, if a husband gifts his fixed deposits to his wife, interest income earned from such fixed deposit shall not be taxable in the hands of the wife but shall be clubbed with the income of the husband.

The clubbing of income would be done in the hands of transferor even if:

  1. The spouse converts the original asset into any other form. Example, Husband gifts money to his wife, who buys debentures with the funds. The interest income from such debentures shall be clubbed and taxed in the hands of the husband.
  2. An asset is transferred to the third person for benefit of the spouse, say if an asset is transferred to the brother of spouse for her benefit.

The clubbing of income shall not be done if an asset is transferred to a would-be spouse before marriage. In this situation, the asset transferred could be taxed as a gift in hands of the recipient if the value of such asset exceeds Rs. 50,000 (see details in Taxability of Gift).

  • Income from asset transferred to son’s wife

If any parent (mother or father) transfers an asset to his son’s wife for inadequate consideration [i.e. son’s wife did not pay an adequate amount for that asset], the income arising from such asset (directly or indirectly) is treated as income of such parent. Such clubbing of income is not done if an asset is transferred as part of alimony given to son’s wife on getting divorced. For instance, if mother-in-law gifts some money to his son’s wife, interest income earned from the fixed deposit of such money shall be clubbed with the income of mother-in-law.

The clubbing of income would be done in the hands of transferor even if:

  1. The son’s wife converts the original asset into any other form. Example, Father In-law gifts money to his son’s wife, who buys debentures from the funds. The interest income from such debentures shall be clubbed and taxed in the hands of the father-in-law.
  2. An asset is transferred to the third person for benefit of son’s wife, say if an asset is transferred to the brother of sister-in-law for her benefit.

The clubbing provisions do not apply when an asset is transferred for inadequate or without consideration by:

  1. Parents to son-in-law (daughter’s husband)
  2. Husband’s Brother (any family member) to sister-in-law
  3. From in-laws to would be daughter-in-law (son’s would be wife). In this situation, the asset transferred could be taxed as a gift in the hands of the recipient if the value of such asset exceeds Rs. 50,000 (see details in Taxability of Gift).
  • Income of Minor Child

Any child below the age of 18 years is considered as a minor child. His income is clubbed with the income of that parent whose income without including minor child’s income is greater, if parents are not divorced. If parents are divorced then the income is clubbed with the income of the parent who has custody of the minor child. The parent is given an exemption up to Rs. 1,500 from the income so clubbed in his or her hand.

The income of a minor child will not be clubbed in the hands of his/her parent, if:

  1. Minor is suffering from any disability or severe disability
  2. Income is generated by minor through manual work, application of skill, talent or specialized knowledge & experience. For instance, Prize money earned by the winner of Junior Indian Idol or Junior Dance India dance, who is a minor child shall not be clubbed with the income of either of parents.
  • Conversion of Self-acquired property into HUF

Taxation of Hindu Undivided Family (HUF) is different from the taxability of individuals in income tax laws. Hindu Undivided Family is a separate entity that can be created by members of a family wherein the members are lineal ascendants or descendants. Only Hindus, Buddhists, Jains and Sikhs can open HUFs. A single person cannot create HUF. In other words, a Hindu Family can create a HUF wherein all members of the family are also considered as members of the HUF.

When any member of the HUF transfers his personal assets to the HUF without any adequate consideration, the income arising from such an asset in the hands of the HUF is clubbed with the income of such member. After the partition of HUF, when an asset is distributed among members of the family, the income therefrom shall be taxable in hands of the holder of that asset and shall not be clubbed with member who originally contributed it to the HUF.

Frequently Asked Questions

Q: Just like income, can losses also be clubbed?

Yes, clubbing provisions also applies to losses as well. It means taxpayer, in whose hands income of any other person is to be clubbed, can take benefit of losses incurred by that other person from the same source of income. Example, Husband gives money to his wife to invest in shares, and wife incurs losses from such transaction, such losses shall be clubbed with the income of the husband. If the husband also has other taxable capital gains, the losses can be adjusted against such capital gains.

Q: Does clubbing apply on income on income?

Clubbing provisions do not apply on second generation income. Example, Husband transfers his house to wife without adequate consideration and the wife uses the rental income from such a house to invest in bank fixed deposit. The interest income from such fixed deposits shall not be clubbed with the income of the husband. It shall be taxable in the hands of the wife.

Q: When provisions for clubbing of income are not applicable?

  1. He gifts money to his wife before marriage. However, it can be taxed as a gift in hands of would be wife (see details in Taxability of Gifts).
  2. He gifts money to his wife who invests the same in non-taxable assets.
  3. He gifts money to his daughter’s husband.
  4. He invests in PPF on behalf of his wife or children.
  5. His wife gets a salary from his business on the basis of her qualification and experience.
  6. He gives a loan to his wife or son’s wife.
  7. He transfers an asset to his wife or son’s wife for adequate consideration, say at market value.
  8. He transfers an asset to his wife on getting divorced.
  9. He gifts any asset to his nephew or niece.
  10. He gifts any asset to his major son.
  11. He gifts any asset to his son’s wife on occasion of marriage.
  12. He transfers his assets to any person which is not revocable during the lifetime of the recipient.
  13. His minor son earns income and he is suffering from any disability or severe disability
  14. His minor son earns income through manual work, application of skill, talent or specialized knowledge & experience.
  15. He creates a trust for the benefits of his minor child. He transfers an asset to such trust with specific mention that the benefit from such asset shall be provided exclusively to the child after he turns 18.

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