New Delhi: Under the Income-tax Law on the one hand there are many important sections which provide tax relief to the tax payer in the form of tax deduction and tax exemption but on the other hand there is section 64 in the same Income-tax Act, 1961 which provides for clubbing of income of the spouse and minor children.
Consequent to clubbing of income the net tax burden particularly of the high net worth individuals would increase.
In this article, an attempt is made to discuss some important aspects of clubbing of income, which if properly adopted particularly by the rich and famous can result into no clubbing of income thus enabling tax saving in the family.
How to ensure that the wife's income is not clubbed with her husband’s income
One of the important aspect of tax planning, is to ensure a steady income not only for oneself but also for other members of the family.
Without proper tax planning, the income accruing, arising or received by the wife of an assessee, might be clubbed with the income of the husband, thereby leading to a higher incidence of income-tax.
Similarly, the income of the husband could be clubbed with the income of the wife for income-tax assessment in certain cases.
Hence, proper tax planning demands the adoption of a legal device by which the income of a wife cannot be clubbed at all with the income of the husband and vice-versa.
For this it is necessary that married lady's income must be from her own separate or independent sources.
She can then be independently assessed in a separate income-tax file, without her income being clubbed with that of her husband, and enjoy a separate exemption up to a total income of Rs 1,35,000 every year in respect of her own income.
She may form the nucleus of her own funds by way of gifts from any one in the world, except three persons namely her husband, her father-in-law or mother-in-law.
In case gifts received are from these three (even though gifts in general are exempt from gift-tax) then the income arising directly or indirectly from them would not be considered as her income but that of the husband, the father-in-law or the mother-in-law, as the case may be, for the purpose of levy of income-tax.
Thus, a married woman may receive gifts from her adult son, her father, mother, uncle, brother, sister or friend, etc.
If this precaution is taken, then the income arising to a housewife or a married working lady would be considered to be her own separate income.
If her funds are insufficient, she may take loans and thus augment her investible resources.
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With the help of her own funds, collected either by way of gifts or loans, she could also enter into a partnership and thus be assessed separately in respect of the share income from the firms.
How a wife can own property in her own name and a clubbing of income
We have seen above how a married woman can have her own independent funds.
She can have her own independent investible funds made up of gifts or loans.
Where tax planning is adopted by a married lady, she could as well own a house.
In many cases, it is advisable from the tax planning angle, to purchase or construct a property through the wife of the assessee, or the main, male member of the family.
If the wife has separate, independent sources of income and investible funds, she may buy a property out of the same or she may buy land in her own name and construct a house thereon.
The property could also be bought by the lady in joint names of herself and any other members f the family.
Where the funds of the wife are insufficient for the purchase or construction of a house property, she would be justified in borrowing money for the purpose.
There is no restriction about the persons from whom she could borrow for the purpose of investing in the house property, including her own husband, father-in-law or mother-in-law.
Similarly, she could also borrow money from her son, brother, sister, other relative, a friend, a bank or any other source.
However, reasonable interest must be paid on the loan particularly where the borrowing is from the husband or parents-in-laws, so that the Income Tax Officer cannot ascribe any element of gift therein.
If these precautions are taken when the house property is constructed or acquired by the wife in her own name or jointly with other members of the family, she would be separately assessable in respect of the income, if any, from the house property.
She can have a self occupied house and take loan and claim deduction for interest upto Rs 1.5 lakhs.
There would be substantial tax savings as a result of deduction on account of interest on loan.
In some cases, she could even let out the house property to her husband for the purposes of business, etc.
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Of course, the rent chargeable by the wife should be comparable with similar rent in the locality.
Give a loan to your wife, not a gift to a clubbing of income
While adopting tax planning in the case of a married lady, we have explained above that a married lady should not take gifts from three prohibited persons, namely, her husband, her father-in-law and her mother-in-law.
The most important source of finance for a married lady is normally the husband.
With effect from October 1, 1998 the gift tax has been abolished but the income from the gifts if from three persons mentioned above then it is to be included in the Income-Tax Act.
Hence, the very purpose of making the gift is defeated and complications might start.
Therefore, generally speaking, a husband should not make any gift to his wife. On the other hand, a husband should give a loan to his wife.
The wife may, in turn, invest the loan amount either in the purchase or construction of a house-property or in the acquisition of shares or in other investments.
The only precaution to be taken in such a case, is that the interest charged by the husband should be a reasonable one.
Transfer of assets to spouse before marriage to a clubbing of income
It is well-known fact, that in terms of Section 64(1) of the Income Tax, 1961, if there is a direct or indirect transfer of assets to the spouse, the income resulting from the transferred assets is clubbed with the income of the transferor.
However, a question arises as to the position, when assets are transferred to the 'prospective' spouse, before marriage.
This point has already been settled by the Supreme Court of India's decision in the case of Philip John Plasket Thomas v. CIT 49 ITR 97.
However, this issue came up again before the Allahabad High Court in the case of CIT v. Ashok Kumar (1996) 217 ITR 251.
Once again it was affirmed, that as the gift was made to the spouse, hence, the income from the transferred assets would not be included in the total income of the assessee because the transfer took place before the date of marriage.
How to club the income of your minor child
Generally speaking, the income of a minor child is to be clubbed with the income of the father or the mother, whoever has the higher income.
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However, a very interesting decision was given by the Supreme Court of India in the case of CIT v. M.R. Doshi 211 ITR 1.
In this judgment the Gujarat High Court held that if the child for whom the benefit was provided, was to receive it on attaining majority the provision contained in clause (v) of section 164(1) was not attracted on the plain reading of clause (v) itself, because, otherwise, the Legislature would not have expressed itself in the manner in which it did.
After discussing the issue at length, the Hon'ble judges of the High Court held that the trusts in the present case have this cumulative effect, that the income therefrom is to be accumulated until the attainment of majority by the assessee's three sons: the cumulative income is then to be divided in three equal shares and one such share is to be paid to each son.
The payment, therefore, is to be made after each of the sons attains majority. Section 64(1)(v) requires, the inclusion of such income as arises to the assessee from assets transferred, otherwise than for adequate consideration, to the extent to which the income from such assets is for the immediate or deferred benefit of his minor children.
The specific provision of the law, therefore, is that the immediate or deferred benefit should be for the benefit of a minor child.
In this case, the deferment of the benefit is beyond the period of minority of the assessee's three sons, since the assets are to be received by them when they attain majority, the provisions of Section 64 (1) (v) have no application.
In view of the above mentioned decision of the Supreme Court of India, substantial tax planning can be adopted by persons with minor children, especially when a trust is created for the benefit of the minor child that provides for accumulations until the attainment of majority of the minor children.
Even in the light of the amendment of Section 64, which provides for inclusion of minor’s income in the income of the father or the other, the above mentioned decision would bring some ray of hope to tax payers, where a trust is credited for the determent of the benefit, until the child attains adulthood.
Talented minor children's income not to be clubbed
Although section 64 provides that the income of the Minor children would be clubbed with the income of father / mother but section 64 (1A) clearly speaks that the provisions relating to clubbing of income of the minor child would not arise in respect of the income which arises or accrues to the minor child on account of manual work done by the minor child or the income arises out of activity involving application of the minor child’s skill, talent or specialized knowledge and experience.
Likewise, the income which accrues to a minor child who is suffering from any permanent physical disability as mentioned in section 80U would not be clubbed with the income of the father/mother.
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How to stop clubbing of the income of the daughter-in-law
If you want to a clubbing of the income of the Daughter-in-law then it is time to maintain a separate Income-tax file for the Daughter-in-law.
Immediately, after the marriage of his son, an assessee can start tax planning for his daughter-in-law.
The daughter-in-law should not receive any gifts, directly or indirectly, from her husband, mother-in-law or father-in-law.
The gifts, if any, received at the time of the marriage occasion should be from such relatives other than the three categories, mentioned above.
Thus, mother, father, brother, uncle, aunt, grandfather-in-law, grand-mother-in-law, brother-in-law, or sister-in-law, can give gifts to her so that she can have independent funds to enable her to have a separate income-tax file and be liable to be separately assessed in a manner that the income from these gifts, etc is not clubbed with the income of her husband.
With the help of such gifted amounts she can join a partnership firm, start an independent business, buy a house property or make other investments.
The income from these sources would exclusively belong to the daughter-in-law and would be liable to tax separately in her own hands for income tax purposes.
Hence, the daughter-in-law may receive any amount of gift from any person in the world other than her husband, father-in-law, and mother-in-law.
Conclusion
For achieving best tax planning for high net worth individuals and to a clubbing of the income of minor child or wife or daughter-in-law tax payers should read in greater depth the provisions as are contained in s. 64 of the Income-tax Act, 1961.
Also please do take care to ensure that there is no cross gift. It may further be noted that other than the above mentioned restrictions there is no restriction on receiving gifts of any sum of money from relatives.
In case gift is received by the spouse or the daughter in law from non relatives than as per section 56 any sum of money (i.e., gift) exceeding Rs. 25,000/- so received would be taxed as income.
This amount has been enhanced to Rs. 50,000/- for the Financial Year 2006-07.
The author is tax and investment consultant in New Delhi for the last 35 years.
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