Clubbing of Income Under the Income Tax Act, 1961 [With Infographics]

After availing deductions under chapter VI-A of the income tax act, when any person finds that he/she still needs to pay taxes then many people tend to divert their own income in their spouse or dependent minor children. However, this is the biggest mistake an individual makes being unaware of the provisions of the income tax act, 1961. An individual should know that as per the income tax act, 1961 an individual is taxed in two ways i.e. for his own income and for income received by someone else i.e. clubbing income. In this column, we will discuss what is clubbing of income, various types of clubbing of income, cases where clubbing of income is not applicable, how to avoid clubbing of income.

What is Clubbing of Income?

The most common principle of taxation is that one individual needs to pay tax for one’s own income. But it is seen that people tend to buy or acquire an asset or property or create sources of income in the name of the other person to divert the income to someone’s head. To tackle this malpractice clubbing of income came into effect in order to make sure that no tax should be escaped if the individual moves assets or income sources within the family.

Income Tax

Clubbing of income means adding the income of another family member with someone. The added total income is counted together and treated a single income. Then the whole income becomes taxable under income tax act, 1961. People have a tendency to avoid or reduce tax liability. So, they divert their income to other family member’s head. That is why income tax act clubs the income that is shown as divided.

Various Types of Clubbing of Income under the Income Tax Act, 1961

There are many ways of clubbing income namely,

  • Investment in the form of a fixed deposit in children’s name.
  • Making assets in the name of wife, son, daughter, mother, unemployed father.
  • Having saving bank accounts in the name of the family members.
  • Various investment schemes like mutual funds for children.
  • Buying shares via Demat account for the family members.
  • Savings in the post office for relatives.
  • Buying property in the name of the family members.

Clubbing of income includes the income earned from investment in the name of the relatives. Such income is added to the earning person’s head and that person then comes under income tax.

Now let’s see the clubbing rules at a glance,

Transfer of income without transfer of ownership right of the asset

If a person retains the ownership of an asset but transfers the income from the asset owned by him to any of his family members i.e. relatives the income generated from that property is taxable in the head the transferor i.e. owner.

Suppose, ‘Arindam’ has a property in his name, and he has given rent to ‘Capitalante Financial Services’ and told the company to credit the rent amount to his elder brother ‘Sabyasachi’. In this case, the payment is credited in the bank account of his elder brother ‘Sabyasachi’. Since ‘Arindam’ has not transferred the ownership right to his elder brother ‘Sabyasachi’, the earning from the property will be clubbed with the income of the ‘Arindam’. In other words, without the transfer of the ownership right of asset the income generated will be taxable in the hands of the owner not in the hands of the person who is receiving such income.

Revocable transfer of Asset

When an asset is transferred under any revocable condition i.e. temporarily not in a government procedure, the income comes from that property is clubbed i.e. added with the income of the transferor. Suppose, ‘Niranjan’ has transferred his house to his Brother ‘Balaram’, and ‘Niranjan’ has the right to revoke the transfer during the lifetime of ‘Balaram’. In this case, the income generated from the house property the income is taxable in the head of ‘Niranjan’ not of ‘Balaram’. The same tax treatment will be applicable if any individual transfers an asset under any revocable condition to his spouse also.

Clubbing of Spouse’s Income

Here are some conditions where your spouse’s income will be clubbed with your income and you will be liable to pay income tax in accordance with the total income.

Condition 1

According to the under section 64 of the income tax act, 1961, if your spouse receives salary, remuneration, wages, commission from a company or a firm where you or your relatives have a voting power of 20% and more or receive a profit percentage of 20% and more, then such income is clubbed with your income. The only exception of this rule is if your spouse receives salary or remuneration or commission on the basis of technical or professional expertise and experience then such income is taxed in the hands of your spouse and clubbing of income is not applicable.

Condition 2

If a person retains the ownership of an asset but transfers the income from the asset owned by him to his spouse, the income generated from that property is taxable in the head the transferor i.e. owner. In other words, without transfer of the ownership right of the asset, the income generated will be taxable in the hands of the owner not in the hands of the person who is receiving such income.

Condition 3

If you have provided any amount of money to your spouse [who is a non-working woman] and from the invested money a certain amount of income is generated, in that case, the income arises from the investment will be taxed in accordance with income tax law, 1961.

The income of Minor child

Any income by a minor child from the fixed deposits in the name of the minor child is to be clubbed with the parent’s income whose total income is higher in case both are working. In the case of divorce, the income of the minor child is to be clubbed with the person who is the legal guardian of the minor child.

The exception of this rule is if the minor child has earned or generates an income because of his own manual work, or by making use of his talent or knowledge or expertise in any field.

The parent may enjoy a deduction of Rs. 1500/- per minor child. In other words, the minor’s income is not clubbed with the income of the parents if the income is less than Rs. 1500/-.  The clubbing of income may not be done when the income of a child suffers from any disability under section 80U.

Suppose ‘Niranjan’ has two minor children – Kamal and MunMun who is disabled. Kamal is an artist and earns an income of Rs. 50 lakh. Since the income is earned on the basis of his own skill, the clubbing of income is not applicable. Further, the earned money i.e. Rs. 50 Lakh is invested in fixed deposit and an interest of Rs. 50k is earned out of that fixed deposit. This interest income will be clubbed with the hands of the parents whose income is higher in case both are working person.

But in the case of MunMun, any income either it is bank interest or profit from investment is not to be clubbed with the income of the parents since she is suffering from disability specified under section 80U.

Clubbing of income of a Major Child

A person may give some money to his child aging over 18 years. Then this child may invest this money in anywhere to generate earning. Any such earning will be treated as the earning of the child. Therefore the earning will not be clubbed with the earning of the parents.

Clubbing of income of a Son’s Wife

If a person retains the ownership of an asset but transfers the income from the asset owned by him to his son’s wife, the income is taxable in the head the transferor i.e. owner. Suppose you have a commercial property in Mayur Bihar, New Delhi, and given rent to ‘Capitalante Financial Services’ and told the company to credit the rent amount to your son’s wife. In this case, the payment is credited in the bank account of your son’s wife. Since you have not transferred the ownership right to your son’s wife, the earning from the commercial property will be clubbed with your income.

Clubbing of Income

Clubbing of income of a Hindu Undivided Family [HUF]

If you transfer a self-acquired property to your HUF as a gift i.e. without charging any amount or charging below the fair market value then it attracts clubbing of income if any income arises from the property or asset under section 64(2) of the income tax act, 1961.

Clubbing of income in case of Gifts from the relatives

Any gift received from any relative is totally tax-free. The gift may be in the form of money, jewellery, property, vehicle or any means. But in the case of non-relatives maximum Rs. 50,000/- as a gift can be received. More than this is taxable. If the value of the gift crosses the limit, the whole gift is treated as income from other sources of that receiver. Any gift received at the time of marriage from either relatives or nonrelatives is tax-free. Here are some exemptions in case of a person, who receives Gifts (either in cash or in any kind) from any person under the provision of Section 56(ii) of the Income Tax Act,

  • Husband or wife i.e. spouse of an individual
  • Brother or Sister of an Individual
  • Sister or brother of the spouse of that respective individual
  • Brother or Sister of either of the parents of the individual
  • Any Linear ascendant or descendant of the individual
  • Any Linear ascendant or descendant of the spouse of the individual
  • Spouse of the person mentioned above.

Can negative income be clubbed?

Suppose Suresh gifts Rs. 1 lakh to his wife Anamika. Minor son Anand has a business where he suffers a loss of Rs. 50k. Now as per the clubbing provision of the income tax act, the profit from business i.e. business income of Anamika will be clubbed with the income of Suresh.  But since the minor child has made a loss so, his income will be clubbed with the income of Suresh and Anamika who have a higher income.

How to avoid clubbing of income

By making use of proper planning any individual can escape clubbing of income. Here are the seven ways to prevent clubbing of income.

Gift loan to your spouse not gift

If you have given a loan to your spouse at a nominal rate of interest, the income from the investment of money would not be clubbed with your income. But you need to be cautious that the loan amount along with interest will be paid eventually in a regular interval.

Make an investment on tax-free investment like PPF, Bonds

Even though the income of your non-working spouse will attract clubbing of income, you can avoid by investing in tax-free investment schemes like Public provident fund, tax-free bonds in your spouse name. On maturity, since PPF is Exempt-Exempt-Exempt product, you will enjoy the tax-free income.

Make an investment for your minor child

In order to prevent clubbing of income, you need to make an investment for such a time period which matures only after he/she attains 18 years of age. After attaining the age of 18 years the income arises from any investment even though you made a contribution, clubbing rules do not apply. Clubbing rules are applicable only for a minor child.

Gifts not received by you but your Hindu Undivided Family

Clubbing provisions are applicable when any individual gifts something to the HUF and generates a regular source of income. So, whenever someone wants to give some gifts to you or your minor child, you should request him to gift to your HUF instead of you. The income earned from that gift is the HUF’s income and such income is not clubbed with your income.

Gift your spouse even if the income is clubbed

Even if your spouse’s income is clubbed with your income in case he/she is non-working you should gift your spouse and make an investment of that gifted money. Suppose you invest Rs. 10 lakh in your spouse’s name and earn Rs. 1 lakh on the investment made. Needless to say Rs. 1 lakh will be clubbed with your income. But if your spouse invests the Rs. 1 lakh and earns Rs. 10k then it will be considered to be your spouse’s income, not yours. And your tax liability will be treated as NIL.

Hope this article will help you to understand the clubbing of income better. Let me know if I have missed any information regarding clubbing of income. If you have any questions feel free to comment so that we can have a discussion. If you have found this post helpful feel free to share with your loved ones.

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