What Is Clubbing Of Income And How To Avoid Clubbing Of Income?

Sharing is caring. However, in the world of tax, sharing means shifting your tax burden on someone else, so as to reduce taxable income. Taxes increase as your income increases. Usually, taxpayers falling in the higher tax slabs, divert their income to a spouse, major children, or parents to avoid paying a high amount in tax.

This is tax evasion. To curb this practice, clubbing provisions were introduced in the Income Tax Act, 1961. Sections 60 to 64 of the IT Act, deal with clubbing of income.

Generally, an individual is taxed only on his/her income. But, clubbing provisions make you liable to pay taxes on some incomes which are ‘clubbed’ along with your own income. This is called clubbing of income. IT department seeks full disclosure and transparency in the case of clubbing of income.

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What Is Clubbing Of Income And How To avoid Clubbing Of Income?

You may invest in the name of a non-earning/lesser earning spouse, major children or parents in Fixed Deposits, NSC, mutual funds, and so on. Any income that they earn on such investments is not considered as their income, but yours. You may have invested with an intention to save and provide for their financial needs, but the IT Act considers it as diversion of income. So, you are taxed on any income earned on these investments.

The intention to club income is to make sure there is no tax evasion when you move assets or income within the family. Be it an income or a loss (if allowed to be adjusted against an income), it cannot be transferred to anyone else and hence, will be 'clubbed' with your income.

Scenarios for clubbing of income:

• Transfer of income to another person without transferring the asset. Say, for instance, you own a property but transfer the rent received from renting it to someone else without transferring the ownership.
• Transfer of an asset where the transfer is revocable. This means that even though you have transferred the ownership of an asset, you have the right to take the asset back.
• It doesn’t matter whether or not you receive a consideration in return for transferring or diverting your income or asset to someone else. You will still be liable to pay tax on such income.

Clubbing spouse’s income with yours:

• If you gift money to a spouse who avails FDs with it, such interest income will still be clubbed with your income.

How to avoid clubbing of income?

• If your spouse reinvests such income (interest income from FDs), the interest earned from such re-investment will not be clubbed with your income. Instead, this income will be taxed in your spouse’s hands.

Confused? We’ll make it really simple. Let’s say your spouse invests the interest earned on FDs in mutual funds. Any income arising from the mutual funds will be considered as your spouse’s income. Therefore, your spouse and not you are taxed.

Transfer of asset to a spouse in an agreement to live apart doesn’t attract clubbing provisions.

• If an asset is transferred before the wedding, clubbing rules don’t apply.
• If the relationship between you and spouse does not exist as on the date of the accrual of the income from an asset that is transferred, clubbing rules don’t apply.

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Clubbing minor’s income with your income:

It is a common tendency to invest in minor children’s names to avoid paying taxes.

• A minor child’s income is clubbed with the income of the parent whose income is higher.
• If the parents of the minor are estranged/separated, then the minor’s income will be clubbed with the income of the parent maintaining the minor child.
• Clubbing provisions do not apply if the minor has earned an income by doing manual work or applying skill, talent or specialized knowledge.
• A taxpayer can claim an exemption of Rs 1,500 or the minor’s income, whichever is less, in case a minor’s income is clubbed with their income.

How to avoid clubbing of income?

• Clubbing provisions do not apply if income accrues to a minor child suffering from disabilities specified under Section 80U of the Income Tax Act, 1961.

If you are paying a salary to your spouse:

• Say you have a substantial interest in an entity and your spouse is earning a salary from that entity. In these cases, your spouse’s income can be clubbed with your income.
• You are deemed to have a substantial interest in an entity, if you along with your relative are entitled to 20% of the entity’s profits.

How to avoid clubbing of income?

• If you are able to justify the salary disbursed to a spouse, then the income will not be clubbed. The taxman decides the validity of your justification based on the professional competency, technical acumen and specific knowledge.

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