It’s a trick as old as the hills — trying to pass off your income as someone else’s to cut tax outgo. But the taxman wised up to this long ago and armed himself with clubbing provisions — Sections 60 to 64 of the Income Tax Act, to be precise. No, you won’t get chased by a sleuth with a club. But you can be made to pay tax on income that’s actually yours but masquerades as someone else’s. Here’s an idea of how clubbing of income works.

Say, you come under the 30 per cent tax slab and your spouse has no taxable income. Let’s open a fixed deposit in the name of the spouse — the interest income on the deposit will not be subject to tax, since it will remain within the tax exempt limit of the spouse, you think.

That’s clever but by half. The taxman will see through your little ruse and include (club) the spouse’s interest income with your income. Ergo: you can’t escape paying tax.

Wide gamut
Clubbing of income comes into play in several cases. If you transfer income to another person without transferring the asset that generates the income, sorry: the income is considered yours. For instance, if you transfer the rent received on a house to your friend without transferring the house itself to the friend, the rental income will be treated as yours.

Now, even if you transfer the asset, but the transfer is revocable — that is, you can take back the asset — the income generated will be considered yours. The exception to this rule is when the asset transfer is not revocable during the lifetime of the transferor, or in case of a transfer through a trust, it is not revocable during the lifetime of the beneficiary.

What if you transferred an asset to your spouse? Would you escape the clubbing of income then? No, not unless you received adequate consideration for the transfer from your spouse.

In the example earlier, even though the fixed deposit would be opened in the name of your spouse, the interest income on it will be clubbed with your income. That’s because you did not receive adequate consideration for the transfer of the money.

Even if your spouse changed the form of the asset, the income earned will be considered yours. So, if you gifted money to your spouse who used it to buy some company bonds, the interest on the bonds will be clubbed with your income.

Also, if you transfer an asset to some other person but the benefit goes to your spouse either immediately or in the future, the income on the asset will be clubbed with yours. The rules are similar if you transfer an asset to your son’s wife. That is, the income from the asset will be clubbed with that of the father-in-law or mother-in-law who transfers the asset, directly or indirectly, without adequate consideration.

Minor issues
Also, income of a minor child will be clubbed with that of the parent, whose income is higher. For example, if the father’s income is ₹10 lakh and the mother’s is ₹8 lakh, the income of the minor child will be clubbed with the father’s income.

In cases where the marriage of the parents does not sustain, the parent who maintains the minor child will be subject to the clubbing of income. In any case, ₹1,500 or the minor’s income, whichever is less, can be claimed as an exemption. So, if the minor’s income is ₹10,000, the income that will be clubbed will be Rs.8,500.

But, if the minor child has earned the income doing manual work or applying his skill, knowledge and talent, then there is no clubbing. So, if your musically gifted 10-year old bags a neat kitty in the Super Singers contest, relax — you don’t have to pay tax on it (but your child may have to). Also, if the income accrues to a minor child suffering from certain specified disabilities under Section 80U of the Income Tax Act, then the clubbing provisions don’t apply.

Finally, if your spouse gets salary from a concern in which you have substantial interest, it could be clubbed with your income. You will be deemed to have substantial interest if you, along with your relatives, are entitled to 20 per cent or more of the profits of the concern.
Clubbing in this case happens if the salary cannot be justified — that is, your spouse is getting it without any technical or professional knowledge or experience.

If the spouse is earning the salary by dint of knowledge or experience, it is not clubbed with your income.

Other exceptions
Income from asset transferred to your spouse is not always clubbed. If the transfer of asset is for adequate consideration, then clubbing of income does not come into play. This allows spouses to exchange assets (say, jewellery for cash) and still not get clubbed by the taxman. Also, if transfer of asset is in connection with an agreement to live apart, there is no clubbing. So also, if the asset is transferred before marriage when the husband-wife relation does not exist.

Similarly, if the relation does not exist on the date of accrual of the income from the transferred asset, there is no clubbing.

So, after a divorce, the spouse who transferred the asset will not face clubbing of income, even if it happened when the marriage was in force. Similar exemptions apply when assets are transferred to the son’s wife.

Anand Kalyanaraman
This article was published on January 31, 2016, in Business Line (The Hindu)