India has a progressive system of Direct Taxation. Which means that the tax liability increases as the income of the assessed increase.
Thus, the taxpayers always seek for various methods to reduce their income tax liability. There are certain legitimate methods to minimize the tax liabilities, however sometime people may choose illegitimate methods to minimize or to avoid their tax liabilities. For example, if a taxpayer’s tax liability is reduced by availing the prescribed tax exemptions and deductions then it is absolutely legitimate to do that. However, many taxpayers in order to reduce tax liability either transfer their assets or exhibit sources of income in name of other persons like wife, parents, children etc.
In order to check and curb these tax avoidance and tax evasion activities, long back the concept of “Clubbing of Income” was introduced in Income tax Act, 1961covered by Sections 60 to 64 of the IT Act.
In this blog, we will discuss the concept and rules of Clubbing of Income under I-T Act.
Concept of Clubbing of Income
The words ‘Clubbing of Income’ itself describe that it means clubbing of someone’s income with someone’s income.
The basic rule of income tax is that a person is taxed in respect of the total income earned by him only. However, under certain circumstances some other person’s income is clubbed with income of taxpayer, which we are going to discuss in this blog. The main purpose of clubbing of income is avoidance of tax evasion.
Rules of Clubbing of income
1. Section 60 – Transfer of income arising out of asset without transferring asset
Whenever a person owns an asset but he transfers the entire income earned out of such asset to some other person such as spouse, children etc. without transferring the ownership. Then as per provisions of section 60 of the IT Act, the income earned out of such asset shall be chargeable to tax in the hands of owner of the asset.
The total income of ‘A’ for the F.Y 2020 – 21 is Rs. 4,50,000/-. Apart from this income A is also earning rental income (House property is in A’s name) of Rs. 2,00,000/- p.a., which he is collecting in his wife’s name. His wife doesn’t have any other source of income.
Now if we see both the cases independently, there is NIL tax liability to be paid by A as well as by his wife.
However, if we club both the income, it amounts of Rs. 6,50,000/- and tax liability as per slab for A.Y. 2021 – 22 would be Rs. 44,200/-.
In order to minimize such practice of diversion of income into one’s spouse or Children’s name, the concept of clubbing of income was introduced in Income tax Act, 1961.
2. Section 61 – Revocable transfer of ownership of asset
In some cases a person transfers the ownership of the asset by keeping a clause in the agreement that the transferor can take back the ownership of the asset anytime in the future. Such type of transfers is known as revocable transfer as the transfer can be revoked and annulled in future.
People make such transfers in order to avoid tax liability occurring from such assets like rental income from a house property.
Let’s try to understand it with the help of an illustration as follow-
‘A’ owns a shop and earns rental income of Rs. 1 Lakh p.a. from that shop annually. In order to save tax, ‘A’ transfers the ownership of that shop to his wife ‘B’ with a clause in agreement that ‘B’ ownership of the said shop will be transferred back to ‘A’ after the expiry of 2 years. Such transfer shall amount to revocable transfer under section 61 of the IT Act, 1961 and all the income like rental income from such shop shall be clubbed in the total taxable income of ‘A’.
“Transfer irrevocable for a specified period” is defined under Section 62 of the I-T act. this provision provides the exception to the provisions of Section 61 stating that it shall not apply to any income arising to any person by virtue of a transfer in following two cases:
- Firstly by way of “TRUST”, and it is not revocable during the lifetime of the beneficiary as per the act, and, in case of any “OTHER TRANSFER”, it shall not be revocable during the lifetime of the transferee.
- Next, the transfer has been made before April 1. 1961, which shall not be revocable for a period exceeding six years.
However, The above mentioned case is applicable only when the transferor has “No Direct or Indirect Benefit” from such income in any case.
Section 63 of the IT Act, defines “Transfer” and “Revocable Transfer”, which is as under:
Transfer – includes any: –
- Agreement or
Now, let’s understand the meaning of Revocable Transfer, it is a transfer which satisfies following be “Revocable Transfer” if: –
- When the transfer agreement contains any clause for the re-transfer either directly or indirectly either of the whole or any part of the income or assets to the transferor in future.
- Further, it empowers the transferor to re-assume power either directly or indirectly over the whole or any part of the transferred income or assets.
3. Section 64- “Income of individual to club with income of spouse, minor child, etc.”
The provisions of this section defines in detail the circumstances where income of spouse, minor child, etc. of individual is to be included in income of that individual.
Let’s discuss in brief about such circumstances where income of spouse, minor child, etc. of individual is to be included in income of that individual
Section 64(1) (ii), 64(1) (iv) – Circumstances of Clubbing of income in case of Spouse
When an Individual’s spouse receives income in the form of remuneration irrespective of its nomenclature like Salary, fee, commission, from a concern in which that individual has a substantial interest then such income, shall be clubbed together in the hands of that Spouse whose total income (excluding such income which is being clubbed) is greater than other spouse.
However, such income shall not be clubbed together when it is earned out of the technical, professional knowledge, qualifications or experience of the spouse of that Individual who has substantial interest in the concern from where such remuneration is earned.
When an individual directly or indirectly transfers the ownership of the asset to his spouse without any adequate consideration, then the income arising out of such asset shall be clubbed with the income of that individual.
Nonetheless, the above mentioned provisions are not applicable, in following cases : –
- First, when such asset/income is received as part of the divorce settlement by the spouse.
- When the asset is transferred before their marriage.
- When the transferor and transferee do not share husband-wife relationship at the time of accrual of income.
- When the asset is obtained by the spouse by giving adequate consideration.
4. Section 64(1) (vi) of the IT Act– Circumstances for Clubbing of income of Son’s wife
Like above provisions, when any asset is transferred to the son’s wife without any adequate or proper consideration then in such case also the income arising out of such asset shall be taxed in the hands of transferor.
Section 64(1)(vii)& Section 64(1)(viii) of the IT Act– Transfer of assets by an individual to a person or AOP for the immediate or deferred benefit of his Spouse [as per sub clause (vii)] or Son’s wife [as per sub clause (viii)].
When an individual trasfers asset either directly or indirectly to any person or AOP without any adequate consideration for the benefit of either his spouse or his son’s wife, in such case also the income arising out of such asset shall be taxed in the hands of such individual.
5. Section 64 (1A) – Circumstances for Clubbing of Income of Minor Child
A ‘Minor’ is a person whose age is less than 18 years in a relevant financial year for Income Tax purposes.
As per the provisions of Income tax Act, the minor is not liable to pay Income tax. Any income earned by a minor child shall be clubbed with the income of either of his parents for tax purposes, subject to prescribed conditions.
Let’s try to understand it with illustration
‘A’ opens “Fixed deposit in the name of his minor child. Thereafter, the interest income earned on such fixed deposits shall be included in income of “A’s” total income.
There are certain exceptions to this rule of Clubbing of Income of Minor Child. The same is discussed as under:-
- If the minor child is suffering from any kind of disability as per Section 80U of the IT Act.
- When the minor has earned such income through his talent, knowledge and skill.
- When the income earned by the minor is through any manual work.
Furthermore, the as per the provisions section 10(32) of the Act deduction of Rs 1500/- is allowed to be deducted from income of that parent in whose income, minor’s income is clubbed.
6. Section 64(2) – Circumstances for Clubbing of income in case of HUF
The Section 64(2)of the IT Act states that when an individual who is a member of HUF transfers his personal assets to the HUF without adequate consideration then the income arising out of such asset shall be taxed in the hands of such individual.
Furthermore, when the said converted property/asset has been the subject matter of a partition among the members of HUF then in such case the income derived from such converted property as is received by the spouse on partition shall be deemed to arise to the spouse from assets transferred indirectly by the individual to the spouse and the provisions of section 64(1) shall, so far as may be, apply accordingly.
By reading above blog we have understood the concept and circumstances where income of some other person is required to be clubbed with some other person’s income. We are also aware of the fact that now a days the Income Tax department tracks almost every transactions entered into by any individual. Therefore, to avoid any tax evasion either purposefully or by mistake, it is better to club above discussed or like income with the income of individual by following provisions of section 64 of the IT Act.