As the deadline of July 31, 2023, for filing income tax returns for the assessment year 2023-24 (or financial year 2022-23) approaches, many taxpayers may be grappling with income tax laws and regulations. One such aspect is the clubbing of income.
The concept of clubbing income plays a significant role in assessing an individual’s tax liability. It refers to the inclusion of one person’s income in the taxable income of another. This provision was created to prevent tax evasion by transferring income or assets to family members who may be in a lower or nil tax bracket.
As per provisions under the Income-tax Act, 1961 (the Act), specified incomes of specified persons will be clubbed while computing an individual’s total income. The clubbing of income-related provisions is applicable in specific situations where income is transferred or diverted to another person. The intention behind such transfers is often to reduce the overall tax liability. The law seeks to ensure that such attempts are not successful by requiring the income to be added to the taxable income of the person who transferred it.
Some of the scenarios where provisions related to clubbing of income get attracted are discussed below:
1. Transfer of Income without transfer of asset
If an individual transfers the income without transferring the ownership of the asset from which such income is earned, then such income will be taxable in the hands of transferor.
2. Revocable transfer of asset
Revocable Transfer refers to a situation when an individual transfers an asset to another person with a clause which empowers the transferor to take back the ownership of such asset anytime in future. In such cases any income from such asset shall be taxable in hands of transferor itself i.e., person who transfers the asset, and not in the hands of the transferee.
3. Income of spouse:
If the taxpayer’s spouse receives any remuneration irrespective of its nomenclature, such as salary, commission, fees, or any other form and by any mode, i.e., cash or in kind, from any entity in which the taxpayer has a substantial interest (taxpayer along with relatives, holds > 20% shares/ voting power in the entity), the income is liable to be clubbed in the hands of that spouse whose income excluding such remuneration is higher.
However, clubbing provisions are not attracted if the spouse possesses technical or professional qualifications in relation to any income arising to the spouse and such income is solely attributable to the application of their technical or professional knowledge and experience.
4. Transfer of assets without adequate consideration:
If an individual transfers an asset, such as property or shares, to their spouse, minor child, or daughter-in-law without adequate consideration, any income derived from such assets will be clubbed with the income of the transferor. This prevents the individuals from transferring income-generating assets to family members in lower tax brackets to reduce their own tax liability.
There are certain exceptions to this, such as:
a. An asset received as a part of a divorce settlement.
b. Where husband-and-wife relationship does not exist on the date of the accrual of income.
c. The spouse acquires an asset using pin money.
5. Income of a minor child:
Any income arising from or accruing to a minor child will be clubbed in the hands of their parents. The income is clubbed in the hands of the parent who has higher income. However, if a minor child earns any income due to manual work or an activity that requires the application of his skill and talent, that income is not clubbed in the hands of the parents.
If a minor child’s income is clubbed in the hands of a parent, then an exemption of Rs 1,500 per child is allowed to the parent. This exemption is available for a maximum of two children.
Clubbing of income is an important concept under India’s tax laws, designed to prevent tax evasion by transferring income to family members in lower tax brackets. Therefore, taxpayers should ensure that any income earned by the family members which is liable to be clubbed with the taxpayer’s income is duly reported in the tax return. This would help avoid the unintended consequences of non-compliance such as interest and penalty on the tax liability due to such clubbing of income.
(Akhil Chandna is partner at Grant Thornton Bharat LLP and Sarthak Prashar is manager at Grant Thornton Bharat LLP)
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