A person must pay taxes on all taxable income produced within a financial year, according to the provisions of the Income Tax Act. If the income of any other member in a family is included when computing the Gross Total Income, this is known as ‘Clubbing of Income.’ Clubbing of income is addressed in Section 64 of Income Tax Act of 1961. This process ensures that people avoid paying taxes by shifting their earnings and assets within the family. The provisions of the Act relating to the idea of income clubbing are briefly discussed in this article.
Did you know?
You can include your family members such as your daughter-in-law under the Clubbing of Income under the Income Tax Act.
What is clubbing of income?
The general concept of taxes is that each individual must pay tax on their earnings. However, it has been observed that individuals buy or acquire an asset or property in the name of another person or generate sources of income to redirect their revenue.
To combat this technique, income clubbing was implemented to ensure that no tax was evaded if an individual moved assets or income sources within the family. The term “clubbing of income” refers to combining the earnings of two or more family members. The total income is combined and processed as though it were a single income. The entire income is then taxed under the 1961 Income Tax Act.
Various Types of Clubbing of Income under the Income Tax Act, 1961
There are a variety of ways of clubbing income, including:
- Various investing options for children, such as mutual funds.
- Having bank accounts under the names of family members.
- Purchasing shares for family members through a Demat account.
- Savings in the post office for relatives.
- Purchasing real estate in the name of family members.
- Making assets in the names of the wife, son, daughter, mother, and father who is unemployed.
- Investment in the form of a fixed deposit in children’s name.
The money obtained from investments made in the names of relatives is included in the clubbing of income. This income is added to the earning person’s account, subsequently subject to income tax.
Also Read: What are the Capital Gains Exemption Under Section 54 of Income Tax Act
Rules regarding Clubbing of Income
Let’s take a quick look at the rules behind clubbing income:
1. Transfer of Income without transfer of asset
If a person transfers the income from an asset without transferring the item itself, the income must be included in the transferor’s total income. It makes no difference whether the transfer is revocable or irrevocable or whether it occurred before or after the effective date of this Act.
Example
Mr. Arun grants his wife, Ms. Shalini, the right to receive rent on his house property without transferring the house itself to her. In this situation, Ms Shalini’s rent will be clubbed with Mr Arun’s earnings.
2. Income arising from revocable transfer of assets
When an asset is transferred under any revocable condition, i.e., temporarily outside of a government procedure, the revenue from that property is clubbed, i.e. added to the transferor’s income.
Assume that Danish has transferred his house to his brother Avram and that Danish can revoke the transfer throughout Avram’s lifetime. In this situation, the income generated by the house property is taxable for Danish rather than Avram. The same tax treatment will apply if an individual passes an asset to his or her spouse under any revocable condition.
3. Clubbing of income of spouse
Here are several situations in which your spouse’s income will be combined with yours, and you will be required to pay income tax on the total amount.
Condition 1
Section 64 of Income Tax Act of 1961 states that if your spouse receives a salary, pay, wages, or commission from a company or firm where you or your relatives have a voting power of 20% or more, or a profit proportion of 20% or more, such income is clubbed with your income. The only exception to this regulation is if your spouse obtains a salary, payment, or commission based on technical or professional knowledge and experience, such income is taxed in your spouse’s hands, and income clubbing is not applicable.
Condition 2
If a person keeps possession of an asset but transfers the income earned by that asset to their spouse, the income created by that property is taxable in the hands of the transferor, i.e. the owner. In other words, if the asset’s ownership rights are not transferred, the revenue created is taxable in the owner’s hands rather than the person receiving the income.
Condition 3
Suppose you have given any amount of money to your spouse (a non-working individual), and a particular amount of income is generated from the invested money. In that case, the income generated from the investment will be taxed according to the income tax law of 1961.
4. Clubbing of income of minor child
If both parents work, any income from a minor kid through fixed deposits in the minor child’s name must be combined with the parent’s income. In the event of a divorce, the minor child’s income is combined with the income of the minor child’s legal guardian.
However, the minor’s earnings from physical labour or any activity requiring their skill, talent, or specialized knowledge or experience will not be counted against his parent’s earnings.
If an individual’s (i.e., a parent’s) income includes the income of his minor kid as defined by section 64(1A), the parent is entitled to a ₹1,500 exemption for each minor child. If the income of any minor so included is less than ₹1,500, the entire income is excluded. Income clubbing is not permitted when a child’s income is affected by a disability under section 80U.
Example
Alok has two minor children, Kamal and Munmun, and Munmun is disabled. Kamal works as an artist and makes ₹10 lakh per year. The clubbing of income is not relevant since the revenue is acquired based on his competence. Furthermore, the earned money, namely ₹50 lakh, is deposited in a fixed deposit, from which interest is earned. If both parents work, the interest income will be combined with the parent’s income whose income is higher.
However, in the instance of Munmun, any income, whether it be bank interest or investment profit, is not to be combined with her parents’ income because she is disabled as defined by section 80U.
5. Cross Transfers
The income from the assets transferred would be assessed in the hands of the deemed transferor if the transfers are so intimately connected as to form part of a single transaction. Each transfer constitutes consideration for the other (e.g., A making a gift of ₹50,000 to his brother’s wife B to purchase a house owned by her and B simultaneously gifting shares in a foreign company worth ₹50,000 owned by him to A’s minor son).
Thus, in this case, A and B made transfers to people who aren’t their spouses or minor children to get around the provisions of this section, demonstrating that the transfers constituted consideration for each other. Under the provisions of Section 56(ii) of the Income Tax Act, a person who receives gifts (in cash or kind) from any person is entitled to certain exclusions.
- Husband or wife, i.e., spouse of an individual
- Brother or sister of either of the parents of the individual
- Brother or sister of the spouse of that respective individual
- Individual’s brother or sister
- Any descendant or ascendant of the individual’s linear ancestors
- Any descendant or ascendant of the individual’s spouse’s linear ancestors
- Spouses of the persons mentioned above.
Clubbing provisions in a Hindu Undivided Family (HUF)
Firstly, HUF, under Hindu Law, is a family consisting of all people descended from a common ancestor. This includes the person’s wife and unmarried daughters.
According to section 64(2), when an individual who is a member of a HUF transfers their property to the HUF without adequate consideration or converts their property into HUF property (by impressing such property with the character of joint family property or throwing such property into the family’s common stock), clubbing provisions apply as follows:
The full revenue from such property will be combined with the transferor’s income before the HUF is partitioned. After the HUF is divided, such property is distributed to the family members. In such a circumstance, income earned from such property by the transferor’s spouse will be combined with the individual’s income and taxed in their hands.
Clubbing of minor’s child’s income with the parents
The income of a minor kid is combined with the income of their parent (*) per section 64(1A). The income of a minor child obtained through physical labour or other activity requiring the application of their ability, knowledge, talent, experience, or other attributes will not be combined with that of their parent. However, the earnings from such income will be combined with the earnings of the minor’s parents.
If the parents’ marriage does not last, the minor’s earnings will be combined with the parent’s earnings who is responsible for the minor’s upkeep.
If an individual’s income includes the income of a minor kid, the individual can claim an exemption of ₹1,500 or the income of the minor child, whichever is smaller, under section 10(32).
(*) The provisions of section 64(1A) do not apply to any money earned by a minor child with a disability as defined by section 80U. In other words, the income of a minor with a disability as defined by section 80U will not be combined with that of their parent.
Example
Mr Raja is the father of two minor children, Anmol and Arjun. Arjun suffers from ailments listed under section 80U, while Anmol is a kid artist.
The following is Anmol and Arjun’s income:
Anmol’s income from stage shows is ₹1,000,000.
Anmol’s bank interest income is ₹6,000.
Arjun’s bank interest income is ₹1,20,000.
Will minor children’s earnings be combined with their parents’ earnings (Ms Sonam, Mr Raja’s wife is unemployed)?
Minor children’s income is combined with the parent’s income, whose income (without the minor’s income) is higher under section 64(1A). Ms Sonam does not have any income in this scenario, so any income that must be combined will be with Mr Raja’s.
Since the income of a minor child gained from manual labour or their skill, knowledge, talent, experience, or other sources will not be combined with their parent’s income, therefore, Anmol’s income from a stage show will not be combined with Mr Raja’s income, but Anmol’s income from bank interest of ₹6,000 will be combined with Mr Raja’s income.
The income of a minor with a disability as defined by section 80U will not be combined with that of their parents. As a result, Arjun’s earnings will not be combined with Mr Raja’s earnings.
Section 10(32) allows the taxpayer to claim an exemption. Thus, in respect of interest income of ₹6,000 included in Mr Raja’s income, he will be entitled to an ₹1,500 exemption under section 10(32), resulting in a net income of ₹4,500 (i.e., ₹6,000 – ₹1,500). The deductee submits a declaration with the deductor, who then records the tax deduction in the other person’s name in the information related to tax deduction referred to in sub-rule (1) of rule 37BA.
Income Applicable for losses
Clubbing provisions will be equally applicable for losses, it’s worth noting that, according to Explanation 2 of section 64, ‘income’ includes ‘loss.’ As a result, if the stated revenue to be included in the individual’s total income is a loss, the loss will be taken into account when computing the individual’s total income. It is worth noting that this applies to both section 64(1) and section 64(2)’s clubbing provisions (2).
How to avoid clubbing of income?
Anyone can avoid financial clubbing by using appropriate planning. Here are some strategies for avoiding income pooling.
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Investing in products like Public Provident Fund (PPF)
You can earn tax-free income by investing in products like PPF in the name of your spouse or minor child because the maturity proceeds of PPF are tax-free. The same is true for equity goods. Additionally, money can be given to senior citizen parents, the minor kid, or a spouse with a lesser tax burden who can invest it in a PPF to generate higher tax-free returns.
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Invest in the name of a non-working wife
The income earned on the money invested or transferred to your spouse is clubbed, but the income received on that income is not. For example, if you bought a house in your wife’s name, the rental income from that house, say ₹50,000, will be clubbed. But if the house is in your wife’s name, any further income created by investing that ₹50,000 rental revenue will not be taxable.
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Loan to your spouse
If you gave your spouse a nominally-interested loan, your income would not include the revenue from the money invested. However, you must ensure that the loan amount and the interest are paid on time.
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Gift money to your wife or daughter-in-law before marriage
If your wife/daughter-in-law is unemployed and has no source of income, you can save up to ₹2,50,000. However, it is important to note that this can only be done before marriage. After your marriage, you will be subject to clubbing requirements if you provide money.
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Pay rent & save money
If you live with your parents and the property is owned by them, then you can pay the rent and get a housing rent allowance exemption. In addition, if your parents have no other source of income, they may be eligible for further benefits. They will be free from paying income tax since they will fall within the basic exemption limit.
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Invest in your minor child
To avoid income clubbing, invest for a time that ends when they reach the age of eighteen. Clubbing regulations do not apply to an individual who has crossed eighteen years of age. Only a minor child is subject to clubbing rules.
Also Read: Deductions under Section 80: Section 80C, 80CCC, 80CCD & 80D Income Tax
Conclusion
Proper awareness of the clubbing provisions of income tax act is critical since they directly affect the income of individuals. In this article, we’ve covered the clubbing of income under the Income Tax Act of 1961. By understanding how the clubbing of income is done, you can take proper measures to avoid clubbing as highlighted in this article.
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