Tax planning should be an integral part of any financial roadmap since one has to forego a substantial part of one’s income from investments or accumulated funds in the form of taxes.

A novel way to reduce one’s tax liability is to gift money to the near and dear ones, particularly those who do not have any taxable income.

However, one should be cautious about gifting money to some specific relatives because in some cases any income arising out of the gifted money is clubbed with that of the donor. Hence, the tax liability of the donor may actually increase.

Take precaution

Let us see the precautions that need to be taken to avoid clubbing of income from gifted money with that of the donor.

According to section 64 of the Income Tax Act, 1961, income of the spouse, minor children and daughter-in-law is clubbed with the individual income tax assessee under certain conditions. These provisions were inserted to counter tax evasion by an individual by distributing the income or financial assets to other family members while still retaining control over such income.

The following are instances where income from gifted money is clubbed with that of the individual assessee:

Transfer of assets to spouse and son’s wife:

n Any remuneration in cash or kind from a concern in which the assessee has a substantial interest

n Asset transferred to spouse or son’s wife without appropriate consideration for their immediate or future benefit

n Income from assets transferred to spouse or son’s wife when reinvested in a business, any income thereon is clubbed in the hands of the transferor/individual assessee

n If there is any accretion to the transferred/gifted asset, such accretion shall not be clubbed. But when the transferred/gifted asset is converted into any other form, income derived from such conversion shall be clubbed

Income of a minor child:

n Income of a minor child is clubbed with that of the parent whose income is higher

n When the income of a minor child is from manual work done by him/her, the clubbing provision doesn’t apply

n When the income of the minor child arises from activities involving application of the skills, talent or specialised knowledge of the minor child, the clubbing provision doesn’t apply

n Income of a disabled child is not clubbed with the income of parent

n Exemption given up to Rs 1,500 per child or the clubbed income, whichever is lower

n If the minor child earns only agricultural income, it is not clubbed with that of the parent for tax rate purposes

n For the income clubbing provision, child includes stepchild and adopted child of the assessee and minor married/unmarried daughter

Therefore, one needs to be careful if one is planning to transfer a sum of money, savings or assets to one’s minor children or spouse or daughter-in-law having no independent income sources.

However, in either of the two cases cited above, there are certain exceptions for genuine transfers of assets.

Exceptions to the rule

If one wants to give some money to one’s spouse in the form of a bank fixed deposit, the interest income from such deposits will be accrued in the name of the recipient, but it will be clubbed with the donor’s income and the latter will have to pay the income tax.

Similarly, if one transfers a house in the name of the spouse without adequate consideration, any income from that property will be clubbed in the hands of the donor.

The transfer of asset itself will not be taxed under the income tax act in the hands of the transferee, but “adequate” consideration has to be paid for the transfer and it has to be judged in terms of the market value.

For example, if one transfers a property having a market value of Rs 10 lakh and fetching an income at an annual rate of 10 per cent to the spouse for Rs 4 lakh, one will have to pay income tax on Rs 60,000 (at the rate of 10 per cent on the inadequate consideration of Rs 6 lakh).

Indirect transfers of assets also attract the clubbing provision. This is meant to cover cases where assets are transferred by setting up trusts or cross transfers. For example, if one gifts an asset to one’s brother who in turn gifts the same to the original donor’s wife. Such a transfer will be clubbed with the income.

Consider another instance where one gifts some money to one’s spouse or daughter-in-law or a minor child and the money is used to buy a property or shares of a company. If the property or the shares are sold and the proceeds are invested in a bank fixed deposit in the name of the spouse/ daughter-in-law/minor child, the capital gains from the sale of the property as well as the interest income from the bank fixed deposit will be clubbed with the donor’s income.

Relief options

However, in cases where the spouse or the daughter-in-law possesses technical or professional qualification and has an independent source of income arising from the application of the technical or professional knowledge, the clubbing provision will not arise.

One has to be careful before claiming protection under this exception since a Bombay High Court ruling has specified that the technical or professional knowledge does not include undergraduate qualification.

There is another way to avoid clubbing of income. Under section 10 of the income tax act, there are specified incomes that are exempted from tax. These include income from Public Provident Fund, life insurance plans, dividend from shares or mutual funds, long-term capital gains from equities and equity-linked mutual fund units.

So, instead of giving cash to one’s spouse, daughter-in-law or minor child, an individual may try these investment options. Income to the recipients from these instruments will not be clubbed with the donor’s income. Besides, the recipients will also enjoy tax-free income.