In India, individuals are generally taxed only on their own income. However, there are situations where a person may have to pay taxes on someone else’s income. This is called clubbing of income, and it is designed to prevent people from avoiding taxes by shifting their income to others, especially family members, who are in a lower tax bracket.
Why Do We Have Clubbing Provisions in Income Tax?
Clubbing provisions in the Income Tax Act aim to prevent tax avoidance and ensure that individuals cannot use family relationships to reduce their tax liability.
Here’s why these rules exist:
- Tax Liability: Normally, you are taxed only on your own income. However, some people try to reduce their tax bills by transferring income to family members who have a lower tax rate or no taxable income.
- Income Shifting: To lower taxes, people often transfer income to spouses, children, or other relatives. This is done to reduce the overall tax burden by exploiting lower tax brackets.
- Loss Transfers: Even if a person has a tax loss, they may transfer the loss to someone in a higher tax bracket to reduce their own tax burden.
To prevent such practices, the Income Tax Act includes Sections 60 to 65, which lay down the rules for clubbing of income.
Situations Where Clubbing of Income Applies
Here are some scenarios where your income could include money earned by someone else:
Transferring Income Without Changing Ownership
If you keep ownership of an asset but allow someone else to collect the income from it, you must report that income on your tax return.
Example: Mr. A owns a house and rents it for ₹32,000 a month. If he asks the tenant to pay the rent into his father’s account, Mr. A still has to report this ₹32,000 as income because he is the property owner.
Income from a Minor Child
The income of a minor child is added to the income of the parent who earns more. If the parents are divorced, the income is included in the parent who has custody of the child.
Example: Mr. B has two daughters. Their fixed deposits generate ₹6,000 each. Mr. B will report ₹12,000 as his income but can claim an exemption of ₹1,500 per child, making his taxable income ₹9,000.
Exceptions: Clubbing does not apply if the income is from the child’s work or skills, or if the child has a disability under Section 80U of the Act.
Income of a Spouse
If your spouse earns income through a business where you have a significant interest, or in cases where the spouse lacks the necessary skills for the job, their income may be included with yours.
However, if the spouse has the required qualifications, this rule may not apply.
Transferring Property Without Fair Payment
If you transfer an asset to your spouse or your son’s wife without receiving adequate payment, the income generated from that asset will be added to your taxable income.
Example: If you transfer a house to your spouse without proper payment, any rental income from that house will be taxed in your hands.
Divorced Parents and Minor Child’s Income
When parents are divorced, the income generated from a minor child’s investments is taxed as the income of the parent who has custody of the child. If both parents share custody, the parent designated in the divorce agreement is responsible for paying the taxes.
Tax Implications of Clubbing of Income
Clubbing of income can push you into a higher tax bracket, resulting in a higher overall tax liability. It’s essential to consider the effect of combined incomes on your tax rates when planning taxes for you and your family.
You must report all clubbing of income on your tax return. Failing to report it can lead to penalties and interest.
How to Handle Clubbed Income When Filing Taxes
If you realize that you’ve missed clubbed income or made an error, you can file a revised return within the allowed time frame. If the revised return leads to a higher tax liability, you may need to pay the extra tax along with interest.
It’s crucial to keep proper records of income, transfers, and investments to avoid discrepancies and ensure compliance.
Importance of Accurate Reporting and Record Keeping
Accurate reporting is essential when dealing with clubbing of income. If you fail to disclose income that should have been included, the Income Tax Department may impose penalties for incorrect reporting.
Examples of Clubbing of Income
Here are some common situations where income is clubbed:
- Spouse and Minor Child: Any income earned by your spouse or minor child, especially if assets are transferred without fair consideration, will be added to your income.
- Income from Transferred Assets: If you transfer assets (like property or investments) to a family member without fair compensation, the income generated from that asset will be taxed in your hands.
- Minor Child’s Earnings: If your minor child earns money, it’s added to the parent’s income, with some exemptions allowed under Section 10(32) of the Income Tax Act.
The rules of clubbing of income ensure fairness in tax payments by preventing individuals from shifting income or assets to lower-taxed family members.
It’s crucial to understand these provisions to avoid tax penalties and ensure you’re in compliance with the Income Tax Act.
Always report all incomes, keep accurate records, and consult a tax professional to effectively plan your taxes.
Frequently Asked Questions (FAQs)
What is Clubbing of Income?
Clubbing of income refers to the practice where income earned by someone else (e.g., a spouse, minor child, or relative) is included in your income for tax purposes. It’s aimed at preventing tax avoidance.
Are There Clubbing Provisions for Transferring Income Without Changing Ownership?
Yes, under Section 60, if you transfer income from an asset but retain ownership, the income will still be taxed to you.
Example: Mr. A transfers the rental income from his house to a friend, but the house remains his. The ₹98,000 rental income will still be taxed in Mr. A’s hands.
Can a Spouse’s Salary Be Added to My Income?
Yes, if your spouse works in a business where you have a significant interest, their salary may be added to your income.
What Is Substantial Interest?
If you or your relatives hold 20% or more of a company’s equity or are entitled to 20% of the profits in a business, you are said to have substantial interest.
Example: Mr. A holds 21% of XYZ Pvt. Ltd., and his wife earns ₹98,000 without relevant qualifications. Her salary will be added to his income.
Does Clubbing Apply When I Transfer Assets to My Son’s Wife?
Yes, if you transfer an asset to your son’s wife without fair payment, any income from that asset will be clubbed with your income.
When Do Clubbing Provisions Not Apply to Income from Assets Given to a Spouse?
Clubbing provisions do not apply if:
- The asset is transferred for adequate payment.
- The transfer is part of a divorce agreement.
- The transfer occurs before marriage.
Can I Claim Tax Deducted at Source (TDS) for a Minor Child’s Income?
Yes, the income of a minor child is clubbed with the income of the parent whose income is higher. If TDS is deducted, it can be claimed by the parent. The parent can also claim an exemption under Section 10(32).
Example: Mr. A’s child earns ₹6,000 in interest. The income will be added to Mr. A’s income, and he can claim an exemption of ₹1,500, resulting in ₹4,500 added to his taxable income.
Do Clubbing Provisions Apply to Hindu Undivided Family (HUF) Members?
Yes, under Section 64(2), if a member of an HUF transfers property to the HUF without adequate payment, the income from that property will be taxed in the hands of the transferor, both before and after partition.
