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May 22, 2000

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To club or not to club

Ganesh Jagadeesh & Co

Clubbing of income: When income received by more than one person is clubbed with a single individual's and such combined income becomes liable for tax.

Adequate Consideration: The reasonably fair value or compensation that could be fetched by an asset if it is sold/transferred. It also includes instances where consideration is more than adequate.

Mohan's house is valued at Rs 1 million. If he sells his house to Rajesh for adequate consideration, Mohan should receive Rs 1 million or more from Rajesh.

Inadequate Consideration: Where an asset is sold/transferred for no value or a value lesser than its fair value, the transfer is said to have been made for inadequate or for less than adequate consideration.

If Mohan gives away his house to Rajesh for free or sells the house for a value grossly lower than Rs 1 million, then such transfer or sale would have been made for inadequate or less than adequate consideration.

So who's responsible?

The person in whose income is included the income of another individual(s). However, the tax department can also choose to recover tax on clubbed income from the person(s) whose income is being clubbed with the income of another individual - to the extent of his/her/their income in the clubbed amount.
Do remember, income getting clubbed could also include negative income or a loss.

If Sheila's income is to be clubbed with her husband Ravi's income, Ravi is primarily responsible to include Sheila's income in his declared income and pay tax on the aggregate income. If due to clubbing, Ravi's income of Rs 100,000 includes the incomes of Sheila (Rs 20,000) and his daughter-in-law (Rs 10,000), then tax can be recovered in any of the following ways:

  • wholly (100 per cent) from Ravi himself; or
  • partly from each of the individuals to the extent of the share of their respective incomes in the clubbed amount (70 per cent from Ravi, 20 per cent from Sheila and 10 per cent from his daughter-in-law).

Why club income?

To check loss to revenue that may arise from transfer of income or assets between individuals without adequate consideration.

If the cost (post-indexation) of Mohan's house is Rs 400,000, then transfer/sale of the house for a value less than Rs 1 million its market value) will result in a lower amount of capital gains tax to be paid by Mohan. Indeed, should the transfer/sale be effected for less than Rs 400,000, a capital loss may result, which can be set off against other capital gains.

To bring diverted income within the scope of tax rates.

Balma's annual income is Rs 200,000 and, in addition, he owns property which earns him an annual rental income of Rs 30,000. His mother Salma has an annual interest income of Rs 25,000. Balma, in an attempt to transfer the rental income to Salma, transfers the property in her favour. This will result in the following:

  • Balma's professional income of Rs 200,000 will get taxed at the highest rate;
  • His rental income now transferred to his mother, who is in the minimum tax category, will be taxed at a lower rate of 10 per cent.
By applying the clubbing provisions, Salma's income from rent will get clubbed with Balma's professional income and by being taxed at the highest rate, will prevent loss of tax revenue.

To prevent tax leakage from situations where income is transferred without transfer of the assets from which it arises.

Manikchand has given a loan to his friend, Moolchand and instructed him that the interest on the loan should be paid to Manikchand's wife. If Manikchand does not declare such interest earned as part of his income, then it will amount to transfer of income (to his wife) without transfer of the asset (loan) from which it arises.

To help administer tax laws effectively by unifying various prospective assessees into a single assessee - income of minor children being clubbed with income of their parents. From the tax payer's perspective, in certain instances, clubbing reduces the inconvenience that would otherwise be caused.

Jupiter has fixed deposits with various banks. He wishes to remit money to his mother (staying in a different city) periodically. To ensure that such remittance is effected in an uninterrupted manner, he has issued instructions to the banks that the interest earned on certain dpeosits - totalling Rs 75,000 - be paid to his mother.
For tax purposes, Jupiter's income will also include the interest received by his mother on his deposits. Jupiter's mother, who does not have any other income, is thus saved the trouble of filing tax returns for the monies received by her.

How do incomes get clubbed?

  • In all cases where an income or asset is transferred for inadequate consideration, the income arising to the transferee will get taxed as the income of the transferor who would have otherwise received it were it not for such an act of transfer.
  • In the case of a minor, his/her income will get clubbed with the income of that parent, having a higher income. If the parent's marriage stands cancelled, then it gets clubbed with the guardian of the minor.
  • The remuneration of an individual's spouse and other members of the family could get clubbed with the individual's income in certain cases.

When do incomes get clubbed?

  • If any person transfers income without transferring the ownership of the asset, such income will be treated as income of the transferor and clubbed with his other income.

Shriman places a fixed deposit with a bank with a standing instruction that the interest earned thereon be deposited in his wife, Shrimati's account. Since the asset (fixed deposit) is in Shriman's name, the interest thereon credited to Shrimati's account will be treated as Shriman's income.

  • If an asset is transferred revocably (temporarily/conditionally). Income arising to any person due to the transfer of assets will be taken to be the income of the transferor if such transfer is revocable or reversible.

If on March 30, 2000, Jairam transfers his property to Balram with the provision that such transfer will be reversed on April 1, 2000, then annual rental income from the property received on March 31, 2000 by Balram will be wholly taxed in the hands of Jairam and not Balram.

  • Assets transferred to spouse or a person for the benefit of spouse. Income arising from assets with a person's spouse will get taxed in the hands of the person if the assets (other than house property) have been transferred to the spouse for inadequate or less than adequate consideration.

Kali transfers debentures owned by her to her husband, Bhairav's name for Rs 50,000. The amount received by her is lower than the market value of the debentures - Rs 75,000. Thus, since consideration is inadequate, any income earned by Bhairav from the debentures will be treated as Kali's income. Income from the debentures would include interest and even, capital gains on sale of the debentures.

  • Income arising from assets transferred, directly or indirectly, without adequate consideration, by an individual to a person or an association of persons for the immediate or deferred benefits of his or her spouse will be included in the total income of the transferor to the extent of such benefit.

If in the example above, Kali transferred her debentures to a trust with Bhairav as beneficiary and her sister, Durga as trustee, the benefits arising from the debentures to Bhairav would still get taxed in the hands of Kali.

  • Assets transferred to son's wife or a person for the benefit of son's wife. Income arising from assets transferred, directly or indirectly, after May 31, 1973, without adequate consideration, to a son's wife will be included in the total income of the transferor from AY 1976-77 onwards.

Sonia transfers bonds worth Rs 50,000 in her daughter-in-law, Caroline's, name for which Caroline pays her Rs 30,000 only. Since the transfer has been effected without adequate consideration, income from these bonds accruing to Caroline will be construed to be Sonia's income for the purpose of income tax. Also, as in the earlier provision, highlighted by the example of Kali using a trust to indirectly benefit her husband, if Sonia transfers her bonds to any other person(s) so that Caroline is benefited thereby, then income from such bonds accruing to Caroline will be clubbed with Sonia's income.

In the above three instances, it's important to remember that the relationship between the transferor and transferee at the time the asset is transferred and when income accrues thereon should necessarily be of husband and wife or father-in-law/mother-in-law and daughter-in-law; else, clubbing provisions will not be applicable.

  • Income arising from conversion of property (after December 31, 1969) into joint family property or transfer to joint family for inadequate consideration, directly or indirectly, of self-acquired property by an individual, who is a member of a HUF will be included in the income of the transferor.

Raj is a member of a HUF. He owns a house valued at Rs 1.5 million acquired out of his own income. If he transfers this house to the HUF for less than adequate consideration, then income arising from the house shall be treated as Raj's income and not as income of the HUF.
Alternatively, should Raj proceed to sell the house and the sale proceeds are transferred to the HUF for inadequate consideration, in such an event too, the income arising from such monies brought into the HUF shall be deemed to be Raj's income and not as income of the HUF.

If after the conversion/transfer of self-acquired property for inadequate consideration, should the joint family be partitioned and as a result, such property is transferred amongst the members of the family, income arising from the property will be taxed in the hands of the respective recipients. In respect of the transferor of the self-acquired property (Raj, in the above illustration), only the income from such converted property received by his spouse will be included in his income.

  • Income of a minor shall be clubbed with the income of that parent whose income, before such clubbing, is higher. Exceptions exist when the parents have been legally separated (then clubbing of minor's income will be with the income of the parent who is the guardian); when the minor's income arises from special skills, knowledge or experience in his/her possession; when the minor child suffers from a disability.

    Exceptions exist when the parents have been legally separated (then clubbing of minor's income will be with the income of the parent who is the guardian); when the minor's income arises from special skills, knowledge or experience in his/her possession; when the minor child suffers from a disability.

Radha has annual income of Rs 250,000 and her husband, Shyam's annual income is Rs 200,000. Interest on fixed deposits Rs 5,000 earned by their minor daughter, Meera will be clubbed with the income of Radha, since her income before such clubbing, is higher than her husband's income.

  • If a person's spouse receives salary or remuneration from a business entity in which the person is entitled to at least 20 per cent of the profits (if the business entity is a firm) or holds at least 20 per cent of the equity shares (if the business entity is a corporate), then such salary or remuneration will be taxed in the hands of the person and not the spouse. This is essentially to ensure that, under the guise of salary to spouse, the person is not transferring income into a lower tax bracket.

Sita draws salary from a partnership firm in which her husband, Ram is the major partner being eligible to 60 per cent of the firm's profits. Her salary income will get treated as Ram's income and be taxed accordingly.
However, if Sita has technical/professional knowledge (such as engineering) and her income were to be derived from such knowledge/experience, then her salary will be treated as her income and not as Ram's income.
Also, if Ram and Sita each are eligible for at least 20 per cent of a firm's profits or hold at least 20 per cent of a company's equity, and both receive remuneration from the organisation, then clubbing of income will be done in the following manner.

Total income, excluding the remuneration, will be ascertained for each person.
In the income of the person, whose total income before remuneration is higher, will be included the remuneration of the other person.

Thus if Sita's total income before remuneration is higher than Ram's total income, then Ram's remuneration will get clubbed with Sita's income.

Who'll pay the tax on income earned from transferred assets?

As discussed above, the transferor is liable to tax on income arising from transfer of assets without adequate consideration. However, if such income, in turn, gives rise to further income, then tax liability on the latter income will rest with the transferee and not the transferor.

Ranga, transfers a house property without adequate consideration to Ganga. Rental income from such property received by Ganga will be taxed in the hands of Ranga, the transferor. If this rental income is placed by Ganga in a bank as a fixed deposit, then the interest earned on this deposit will be taxed in the hands of Ganga, the transferee and not Ranga.

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