Clubbing of Income: Tax rules on asset transfer to family members explained

The income tax department has recently issued a new brochure stating that under Section 64(1)(vi) and 64(1)(viii), any income generated from assets transferred to a son's wife, either directly or indirectly, will be taxable in the hands of the transferor, if the transfer was made without adequate consideration.

 

What is clubbing of income?

 

Generally, individuals are taxed solely on their own income. However, in certain instances, the income of another person may be 'clubbed' with that of the taxpayer, making them responsible for paying tax on both their own earnings and the income of others. This practice, known as clubbing of income, occurs in certain situations, for instance when a minor’s income is included in the parent's taxable income.

 

Kunal Savani, Partner, Cyril Amarchand Mangaldas explains why clubbing of income is done

 

According to the Income Tax Act, everyone must pay taxes on their own income. To prevent people from reducing their tax liabilities by shifting income/transferring assets for an inadequate consideration to their family members, the rule of clubbing of income ensures that income and assets transferred within a family are still taxed properly.

 

What are the key provisions under clubbing of income?

 

Section 60: Transfer of income without transfer of assets

 

If a person transfers income to another individual without transferring the underlying asset, the income remains taxable in the hands of the original owner.

 

Section 61: Revocable transfer of assets

 

When an asset is transferred with the possibility of being revoked at any time, the income generated from it is taxable in the hands of the transferor.

 

Section 64(1)(ii), 64(1)(iv), 64(1)(vii): Income from assets transferred to spouse

 

If an individual transfers an asset to their spouse (except in cases of separation by agreement), the income derived from that asset will be added to the transferor’s taxable income.

 

Section 64(1)(vi), 64(1)(viii): Income from assets transferred to Son’s wife

 

Any income generated from assets transferred, either directly or indirectly, to the son’s wife is taxable in the hands of the transferor.

 

Section 64(1A): Income of a minor child

 

A minor child’s income is clubbed with the income of the parent earning a higher income. However, exceptions exist for income earned through manual work or specialised skills.

 

Section 64(2): Income from property transferred to a Hindu Undivided Family (HUF)

 

If an individual transfers property to an HUF without adequate consideration or converts individual property into HUF property, the income from such property is taxable in the hands of the original owner.

 

Exceptions to clubbing of income:

 

Income from personal skill or manual work: Income earned by a spouse through personal skill or manual work is not subject to clubbing.

 

Income of a minor child: The income of a minor child on which clubbing applies can be reduced by an exemption of Rs 1,500 per child, as provided under Section 10(32).

 

Income of spouse from independent funds: If the spouse earns income from assets acquired out of their independent funds, such income is not clubbed.

 

Amit Bansal, partner, Singhania & Co. explains tax implications of clubbing of income

 

If income is clubbed, the tax implications are as follows:  

 

The income from the transferred asset is added to the taxable income of the transferor and taxed at their applicable slab rate.

 

If the asset itself is later transferred or sold, the capital gains tax liability remains with the transferor.

 

Any reinvestment of income (e.g., interest earned on transferred assets is reinvested) is considered the recipient’s income and is not clubbed further in the hands of the transferor.

 

Clubbing provisions mainly apply under Section 64 of the Income Tax Act, covering cases like transfers to spouse, son's wife, or minor children.

 

Let us understand with example:

 

A father transfers a fixed deposit to his daughter-in-law without taking any payment in return. The interest earned on the FD will be taxed as the father’s income rather than the daughter-in-law’s, as per Section 64(1)(vi).