Plan to save tax: We’re constantly searching for methods to avoid paying taxes. Purchasing assets or making investments in the name of the spouse in the lower tax bracket is a common strategy used by many married couples to achieve this. The spouse in the higher income-tax bracket does this. This is being done with the intention of paying less tax than what would have been due on the income from these assets.
The Income-tax Act contains provisions on “clubbing of income” (covered under sections 60 to 64, and also under section 27 in case of transfer of house property) to address situations of tax avoidance, even though this may seem like a clever trick.
Ways & Means
Most savings instruments allow investment in the name of spouse, children or parents, but with some restrictions. It is common to open a fixed deposit or buy insurance in the name of spouse or minor children. One can even open a Public Provident Fund (PPF) account or buy stocks in the name of spouse or children.
This can be done in two ways. One is joint holding, the first holder being the person in whose name you want to invest, or by transferring the amount/asset to the person who will make the investment. The person in whose name the investment is made (except minors) must comply with the know-your-customer (KYC) norms.
In joint holding, the person whose name appears in the application first must comply with the KYC norms. All correspondence will be addressed to him/her. Even cheques/drafts will be drawn in his/her name.
In case of minors, the person making the investment should comply with the KYC norms. Under KYC norms, a person has to furnish identity/address proofs and the Permanent Account Number issued by the income tax department.
Clubbing of Income
Any transfer of assets to close relatives (parent, spouse, sibling, lineal ascendant/descendant) is not taxed.
Many people use this rule to transfer assets to others who are either in a lower tax bracket or do not pay tax at all and save tax on income from these assets.
To check this, Section 64 of the Income Tax Act contains clubbing provisions as per which any income from investment made or assets purchased in the name of close relatives (spouse, minor child or daughter-in-law) is clubbed with the income of the person making the investment and taxed accordingly .
This applies to all types of investments such as shares, fixed deposits, land, building, post office savings and mutual funds.
Further, income from assets transferred directly or indirectly other than for adequate consideration to a person or association of persons who may benefit the individual’s spouse or son’s wife is also clubbed with the transferer’s earnings.
So, if a person opens a fixed deposit in his wife or minor child’s name, the interest earned will be clubbed with his income. Also, if a person buys a property in the name of his wife, who has not contributed any money, the rental income will be clubbed with his income.
However, if the spouse/relative has a source of income and has bought the asset through his/her own funds, the income will be taxed in his/her hands.
If the property is bought from funds contributed equally by both husband and wife, and is held jointly, the rental income will be split and taxed separately.
Even in case of minor child if the income is from the child’s own skills, manual work, etc, such income will be directly taxed in the hands of the child. All other income will be clubbed in the parent’s hands. The parent may claim an exemption of Rs 1,500 per minor child if the clubbing provisions come into play.
Method of operation
How does this usually operate? Assume that Mr. X pays taxes at a rate of thirty percent and his wife at a rate of ten percent. In order for his wife to be responsible for paying taxes on any income from his assets—such as dividends from shares, rental income from real estate, or capital gains from the sale of shares or property—he uses his income to purchase assets (stocks, mutual funds, or real estate) in her name or to transfer his current assets to her.
As an alternative, suppose he only gives her the rent from his property rather than transferring it altogether. He requests that his renter deposit the money into his wife’s account. In this manner, it can be included in her income, which is subject to a reduced tax rate.
According to the clubbing provisions, Mr. X, the transferor, should have been taxed on the income from these assets in both of these cases. The income tax (I-T) department may send him a notice if he doesn’t comply. Then, in addition to the tax owed, Mr. X will be required to pay a penalty that may equal as much as 200 percent of the total tax owed.
The purpose of the clubbing provisions is to guarantee that all income is subject to taxation in the individual’s name. Transferring income-producing assets or the income from them to another individual will not prevent that.
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