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Understanding clubbing of income and what are the common mistakes

05 Jan 2023

When Rajat Mehta got an email from the income tax department he was actually quite surprised that the department had asked him to add his son’s income into his own income and file revised returns to give a better reflection. It was only when Rajat spoke to his tax advisor that he realized that there was something called clubbing of income of which he was totally not aware of. Many of us tend to distribute incomes among family members to reduce our tax liability. The tax department has the audit trail to track it down and even if you may have done it innocently you will be still required to pay the higher tax along with a stiff penalty. What is the clubbing of income meaning and how to avoid clubbing of income that increases your tax liability? Also what is the unaddressed clubbing of income problems and what must tax payers be aware of.


Firstly, what do we understand by clubbing of income?

 Clubbing of income means that under certain special circumstances the income of your spouse or your minor son or daughter will be clubbed to your income and you will be assessed accordingly. The idea of the tax department is to ensure that taxpayers do not try to escape their tax liability under the garb of family member’s income. Normally, clubbing of income becomes applicable in two cases. Firstly, if you continue to own an asset like property or shares and just transfer the income from the asset to your family member then it will be clubbed with your income. Secondly, if you transfer the asset on a revocable basis, then it will not be treated as a genuine transfer and any income arising out of the asset will be clubbed into your tax liability.


What are the circumstances under which income is clubbed?
Income of your family member can be clubbed with your income under any of the following circumstances..

If you run a company in which you have a substantial interest and if the company pays a salary to your spouse then the salary to your spouse will be clubbed as your income. However, if the payment is done for a specific role or for specific skill sets provided by your spouse then the income will not be clubbed and your spouse can file the returns separately.

Quite often, people tend to transfer assets to their spouses or relative below the market price. For example if you transfer an asset worth Rs.5 lakh for Rs.50,000 to your spouse then what happens? Only 1/10th of the income will be taxed as income in the hands of your spouse and 9/10the of the income from the asset will be clubbed with your income.

It is quite common for taxpayers to give money to their spouses that they may choose to invest in shares or debentures. While the income will accrue to your spouse, it will be treated as clubbed income in your hands since the transfer of money was without any real consideration. However, if that money is given as a loan with interest then it will be included in the tax returns of your spouse.

What happens if your open a fixed deposit in the name of your minor son or daughter who has not yet attained the age of 18. In that case, the interest received from the FD will be clubbed with that of the parent. In case both the parents are filing returns then the income of the minor will be clubbed with the parent who has higher income. However, there is an exemption up to Rs.1500 per year. Also the income will not be clubbed if the minor has earned money through his or her own effort and skill.

While the income of a minor can be clubbed with your income, the income of a major child who has attained the age of 18 will not be clubbed with your income. In that case, the major child will have to file their own returns and pay tax if applicable. Here we are referring to situations where the major child makes investments from the funds provided by you.

There is one more reason or clubbing of income and that is when you give a gift to a relative in excess of Rs.50,000 either in the form of cash or in the form of movable or immovable assets. Any income earned on gifts made above Rs.50,000 will be clubbed with the giver and taxed accordingly.

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