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Provisions for clubbing of income for Income Tax – And how to use them to your benefit

Did you know that some other peoples’ income can be included with your income for the calculation of income tax? But there are ways of avoiding it. Read on!

Consider this: Ajay falls in the highest tax bracket. So, he gift’s some of his money to his wife who is not earning anything otherwise, and invests it in a fixed deposit. In other words, he invests in his wife’s name.

His logic is that since his wife doesn’t have any income, interest earned on such money would be below taxable limit and therefore, she won’t have to pay any tax on such an income.

(Related reading: Income Tax (IT) Slabs / Brackets and rates)

But he is mistaken – in a scenario like this, the provisions of “clubbing of income” apply, effectively resulting in no tax saving for Ajay.

 

What is clubbing of income

“Clubbing of income” means that some income that is not apparently yours is included in your income for the calculation of income tax. Such an income that is included in your income is called your “deemed income”.

This provision of the Income Tax (IT) Act tries to eliminate malpractices like the one described in the above example where people do not pay income tax that is genuinely due from them.

Clubbing of income is covered under sections 60 – 65 of the Income Tax (IT) Act.

 

Clubbing of husband / wife’s income

The clubbing provision applies when you transfer an asset other than a house (say, debentures) to your spouse without charging anything (that is, gift it to your spouse) or while charging a rate below the market rate.

In such a case, income from such an asset (say, interest received from the debentures) would be included in your income for the calculation of income tax.

Important note

For this clubbing provision to apply, the relationship of husband and wife has to exist. Thus, if you gift an asset to your to-be-wife, income from such an asset would not be clubbed with your income – not even after marriage.

 

Clubbing of daughter-in-law’s income

The clubbing provision kicks in when you transfer an asset to your daughter-in-law without charging anything (that is, gift it to her) or while charging a rate below the market rate.

In such a case, income from such an asset would be included in your income for the calculation of income tax.

Important note

For this clubbing provision to apply, the relationship of father-in-law & daughter-in-law has to exist. Thus, if you gift an asset to your to be daughter-in-law, income from such an asset would not be clubbed with your income – not even after your son’s marriage.

 

Clubbing of income of a minor child

Income earned by a minor child is clubbed with the income of one of the parents. As you would have guessed by now, it is clubbed with the income of the parent whose total income is higher!

So, if your wife earns less than you, you can’t add your daughter’s income to her income – it would be added to your income for calculating income tax.

Income upto Rs. 1,500 per annum is exempt – only the income above this is clubbed. Also, if the income has been earned by the child due to her skill or talent, such an income would not be clubbed.

 

Clubbing of income of a Hindu Undivided Family (HUF)

The clubbing provision applies when you transfer a self acquired property to your HUF without charging anything (that is, gift it) or while charging a rate below the market rate.

In such a case, income from such an asset would be included in your income for the calculation of income tax, and not included in the income of the HUF.

 

Important consideration – Income earned from the income earned is not clubbed

Ok, the above heading is confusing! The alternative – “compounded income” – is equally confusing!

So let’s understand this using an example.

Let’s say you invest Rs. 10 Lakhs in your wife’s name, and the interest earned on it is Rs. 80,000. This Rs. 80,000 would be added to your income for the computation of income tax.

However, when your wife invests this Rs. 80,000 in another FD and earns Rs. 6,400 as interest on it, this is considered to be her own income, and is not clubbed with your income.

 

How can you plan income tax around the clubbing provisions?

Here are some ways in which you can plan your taxes around the clubbing provisions:

 

Plan ahead and gift before the wedding

Since clubbing applies only when the other person is your wife or daughter-in-law, you can plan a little ahead and smartly gift assets before the marriage! This way, the clubbing provision would not apply even after the wife / daughter-in-law relationship is established.

 

Gift away even if the income is clubbed

Since income on income is not clubbed, this might still be advantageous to you if you earn a lot and your spouse doesn’t.

Going back to our example, you would pay tax on Rs. 80,000 but not on Rs. 6,400. Had you not gifted the money to your wife, you would pay tax on Rs. 80,000 AND on Rs. 6,400.

 

Take gifts in the name of your Hindu Undivided Family (HUF)

Clubbing provisions apply when YOU gift something to your HUF. They don’t apply when someone gifts something to the HUF – income earned from such gifts is not clubbed with your income.

So, for example, if you are celebrating your son’s birthday and expect some big-ticket gifts, request them in the name of the HUF instead of your son’s or your name. Any income generated from this would be the HUF’s income, and not yours.

 

Give a loan, not a gift

If you loan money to your spouse while charging a reasonable interest on it, income generated from such loaned amount would not be clubbed with your income.

But your spouse needs to be careful – the interest amount needs to be paid regularly, and the original loan amount needs to be returned eventually.

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