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Unvelling the Secret of Clubbing of Income Under Income Tax Act, 1961.




Section 64 of the Income Tax Act addresses the concept of clubbing of income,


Clubbing is done to prevent people from transferring their income to family members or related parties to take advantage of lower tax rate or other type of tax benefits and if income is deliberately transferred then tax authorities may add or club the income transferor to form the income of transferor.


It is a mandatory provision. Under this section, net income is clubbed in certain scenarios.


  • Section 60 pertains to the transfer of income without the transfer of assets,

  • Example -Mr. A owns a property that generates rental income. Instead of receiving the rental income in his own name and being taxed at his applicable tax rate, he makes an arrangement for the income to be credited directly to his friend, Mr. B's bank account. However, Mr. A continues to own and control the property.

  • In the above example the income will be clubbed in the hand of Mr A.

 

  • Section 61 deals with revocable transfers of assets. If an asset or the income related to such an asset can be revoked in the future, the income is taxable in the hands of the transferor.

  • Example - Mr. Ram owns a house, and he decides to transfer the ownership of that house to his friend, Mr Sumit However, Mr. Ram has the power to take back the ownership of the house at any time.

  • Here any income generated from the house such as rental income will be taxed in the hands of Mr Ram.

 

  • Section 64(1A) specifies that three types of income, namely income from skill and talent, income from manual work, and income earned by a handicapped minor, are not clubbed and are taxable solely in the hands of the minor. For other income earned by a minor, it is clubbed either with the parents whose marriage subsists or, in case of the absence of such a marriage, with the parent maintaining the child. Deductions of ₹1500 per child are applicable when minor income is clubbed.

 

  • Example – Rashmi earns income as a Under 16 cricket player, this income earned  by her is not going to be clubbed in the hands of his parents as this is earned from her own skill and talent.

 

  • Section 64(1)(iv) addresses the transfer of assets to a spouse for inadequate or no consideration. If the asset is a house property, the income is clubbed as per Section 27, assuming the transferor is the deemed owner.

  • If the asset is not a house property, the income is clubbed with the transferor as per Section 64. This provision is not applicable if the husband-wife relationship does not subsist. If the nature of the asset changes due to the transfer, the income is clubbed with the transferor.

  • Example: Mr Raju transfer his portfolio in the name of this son and earns the dividend and interest from the portfolio.

  • In this case the income from the portfolio is going to be clubbed in the hands of Mr Raju.

 

  • Under Section 64(1)(vi), if an asset is transferred to a son's wife, the income from that asset is clubbed with the transferor. The same applies if the asset is transferred to a third person for the benefit of the son's wife or wife.

  • If a person has substantial interest in an organization and that organization pays remuneration to the spouse without any qualification, the income is directly clubbed with the person having substantial interest. Substantial interest constitutes 20% voting rights in the case of a company or 20% of profits in other cases.

  • Example: Rakesh is a majority shareholder in ABC Ltd., holding 30% of the voting rights. The company, in which Rakesh has substantial interest, decides to pay a salary to Mrs Rakesh, Mr Rakesh’s spouse, without any specific qualifications or job responsibilities.

  • Since the above case falls clearly under the ambit of Section 64(1)(vi) the income will be clubbed as per the provision of Section 64(1)(vi) in Hands of Mr Rakesh.

  • In cases where both spouses have substantial interest and both receive remuneration, the income is clubbed with the person having higher income. If the transferred amount is invested in business by the transferee, the profit is clubbed with the transferor using the formula: profit * gifted amount / capital employed. Furthermore, if two transactions are interconnected and form part of the same circuitous method to evade tax, the provisions of clubbing are triggered.


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