Hoodwinking taxman using family is difficult

Returns on investments received by a housewife will be taxed; parent or spouse gifting an asset will usually need to pay tax and a minor's income is clubbed with parents', with some exceptions

If you are in the highest income-tax bracket and your wife is in the lowest, this is typical advice your friend will give: Open a fixed deposit in your spouse's name to save tax, so that the return on investment can be shown as his/her income. The income tax (I-T) department, however, is one step ahead. Under the I-T laws, such returns will be clubbed with your income (transferor's) and not the spouse's.

The I-T laws for dealing with such situations is called "clubbing of income" and they define how such transactions will be taxed. "Clubbing provisions apply not only to income but to losses incurred as well. Sometimes, these provisions may give advantage to the tax-payer, as the loss of the person with lower or nil taxable income would also be clubbed with the person who has higher taxable income and thereby reduce his tax liability to that extent," says Amarpal Chadha, tax partner, EY.

Spouse as director or employee:
Many business persons appoint spouses as directors in their private limited companies and pay them remuneration. This remuneration is then shown as an expense. The catch: Spouse needs to have the technical or professional knowledge or expertise to justify the remuneration. "Otherwise, the remuneration will be clubbed," says Tapati Ghose, Partner, Deloitte Haskins & Sells.

So, a software professional's doctor spouse is unlikely to get a tax benefit. But, if he or she is a software professional, there won't be a problem.

Investment of money saved from household expenses: There are no specific provisions in I-T laws for this but many court judgments. "It would not be right to say that the wife cannot make a saving from household expenses paid to her. Such savings cannot be considered as an asset transferred to the wife," says Chadha. Returns on investments received by the housewife will, therefore, be considered her income and she will have to pay tax. The taxability will remain the same even if the wife works.

However, if the volume of savings is on the higher side, it could be contended by the revenue authorities that the intention of such savings is to evade tax by the husband and that the income from the same may need to be clubbed in his hands, says Chadha.

Rental income from property transferred to child: If a parent transfers a property to a minor child, the parent will be considered as deemed owner of the property, under Section 27 of the I-T Act. The rental income from the property will therefore be taxable in the hands of the father.

In case of transfer of the house property to an adult child (irrespective of being employed or not), it is important to identify if the transfer is revocable or irrevocable by the parent. A transfer can be called revocable if the person transferring the property can re-assume right over the property or income (directly or indirectly). Also, if the transfer contains a condition to re-transfer the property to the transferor, it is called a revocable transfer. In this case, the rental income will be clubbed with that of the parent. In case of an irrevocable transfer of the house, clubbing provisions are not applicable and the rental income is taxable in the hands of the adult child.

When a minor works: Usually, the income of a minor child is clubbed with the parent's. But, if the minor earns money because of manual work or any activity involving application of his or her skill, knowledge, talent and experience, the minor has to pay tax on the income.

Minor wins a lottery or competition: If a competition involves the child using skill, talent or specialised knowledge, he or she will pay tax otherwise, the income will be clubbed with parent's. "In case of a lottery, the winning sum will be clubbed with the income of the parent whose income is higher (before including the income of the minor). The parent can claim a deduction up to Rs 1,500 on the minor's income wherever it is clubbed," says Ghose.

JOINT BANK ACCOUNTS CAN BE TRICKY

• Both husband and wife can operate it
• Filing returns can be tricky
• Couple have to segregate the money each one has contributed
• Withdrawals have to be segregated as well
• For taxation of interest earned, the first holder will need to bear the burden
• Bank will also deduct tax at source against his or her name

Example: Suppose a husband and wife put Rs 50,000 and Rs 1 lakh in the bank account. If the husband invests Rs 75,000 from this joint account, their accounts have to be aligned to show the tax department that the Rs 25,000 that the husband used for investment was given back to wife. "If it is not possible to ascertain the value of contributions made by each partner to the joint account, a reasonable assumption can made," says Amarpal Chadha of EY