“You Earn You Pay” or “Pay as you Earn”, these are common lines we all regularly hear but it’s not the case always, many times you also need to pay tax on the other’s income. Clubbing provisions have been included under the income tax to report income in such cases. Let us see the cases as defined by the tax laws where others income is clubbed with the taxpayer’s income and he/she is required to pay tax on it.
Various Scenario of Clubbing of Income
1. Tax on Investment Income through Joint Account
In India, most of us go for some sort of Joint Account after marriage but we tend to forget the taxation aspect on the same. Any sort of income from the investment done from the joint account such as fixed deposit interest, interest from savings account etc. is taxable in the hands of the Primary Account Holder.
In case, the joint account is opened with spouse, then make sure that the primary holder should be one whose income is less so that the tax impact would be low on the income earned from the Joint Account. If the bank interest exceeds ₹.40,000 per annum (earlier ₹.10,000) then bank would deduct TDS in the name of primary account holder. For example if Sanyam, who earns ₹.6 lakhs per annum opens joint account with his wife Ankita who earns ₹.1.80 lakhs per annum then Ankita should be the primary account holder because the tax impact would be lesser. Further, any withdrawals made by the relative would be considered as a gift to the relative under the Income Tax Act but since the gift to the relative is tax-free, there would be no tax liability on the recipient.
There are several occasions where two non-relative persons open joint-account. The taxation on the income from the joint account with non-relative shall be similar to the joint account opens with relative. However, any withdrawals from the joint account exceeding ₹.50,000 per annum would be treated as a gift under section 56 of the income tax act and the same shall be added in the hands of the recipient and taxed as the applicable tax rate.
2. Transfer of Income without transfer of assets or revocable transfer of assets
Rental Income is one of the most preferred passive incomes which almost everyone prefers to have. Since rental income is chargeable to tax people do tax-planning and transfer income by drafting an agreement without the legal transfer of assets but this move does not suffice the purpose of tax-planning. Taking rental cheques in the name of spouse, father, mother etc. without the transfer of the ownership does not transfer the tax-liability. Further, even if the ownership is transferred but through the revocable agreement, the income arises from assets continues to be clubbed and taxed in the hands of transferor.
For example, Sanyam owns house property in Jaipur which he rented at ₹.15,000 per month. He requested his tenant to make the rent’s cheque on his mother’s name. In this case, mere taking cheque on mother’s name does not divert the tax liability on Sanyam’s part. The rental income is to be clubbed with the Sanyam’s income and taxed accordingly since he is the legal owner of the house property.
3. Income of Minor Child (less than 18 years old)
Any income of the minor child should be clubbed with the parent whose income is higher. If the parents are divorced, then the income shall be clubbed with the parent who is taking care of the child. Once the income is clubbed with the one’s parent income, the same shall continue in the future until the tax officer believes any changes are required. The parent with whom the income of the minor is clubbed will be allowed a deduction to the lower of ₹.1,500 per annum per child or the actual amount of the income.
For Example, Sanyam has two kids and has fixed deposits in their names whose annual interest comes ₹.5,000 each. Now Sanyam is required to add the interest income for ₹.10,000 as income from other sources and he is also allowed to claim the
However, clubbing provisions of the minor’s income are not applicable when,
- Income arises from the skills or specialized work or experience of the minor; or
- Minor is disabled (as stated under section 80U of the Income Tax Act) and earns income.
4. Income from taxpayer’s spouse due to substantial interest
The income of the spouse is required to be clubbed with the taxpayer’s income if the same is earned by the way of salary, incentive, commission, fees or any other form of remuneration, from a concern in which taxpayer has as substantial interest.
Substantial Interest means you together with your relatives including husband, wife, brother, sister or lineal ascendant or lineal descendant, hold equity or voting power of a company which is 20% or more or in case of a firm you are entitled to 20% or more of the profits.
However, the clubbing provision does not applicable if spouse possess some technical or professional knowledge and the income is earned through these skills.
For Example, Sanyam has a substantial interest in a company and his wife Ankita is receiving commission from this company without possessing any experience, technical skills or professional knowledge. In this case both the salary of Sanyam and commission earned by Ankita shall be clubbed and taxed in the hands whose income is higher before clubbing.
However, if this commission is earned by Ankita by applying any experience, technical skills or professional knowledge, the clubbing provisions will not be invoked.
5. Transfer of Asset without Adequate Consideration
Under Income Tax Laws there are stringent clubbing provisions on a transfer of any asset without adequate consideration to the spouse or son’s wife. Income earned from such assets is to be added to the transferor’s income if:
- Transferring asset to the spouse without adequate consideration or in connection with an agreement to live separately (does not include the asset transferred as a part of the divorce settlement); or
- Transferring asset to son’s wife, directly or indirectly, without adequate consideration; or
- Transferring asset to any other person or association of persons, directly or indirectly, without adequate consideration, for an immediate or deferred benefit of spouse or son’s wife.
However, the income earned from the assets transferred is reinvested and earns further income then such income may not be clubbed with the transferor’s income.
For example, rental income earned from the house transferred to the spouse without adequate consideration or through revocable transfer deed is to be added in the taxpayer’s income and taxed. But if the rental income further invested by the spouse and earned income then the same is to be taxed in the hands of the spouse and not the transferor.
Tax-Planning should be done while keeping the above clubbing provisions in mind as when the clubbing provisions are invoked and you forget to comply with, it may lead to tax, interest and penal consequences.