Gift Tax and Clubbing of Income

I am unable to invest properly in the names of my wife and other family members as the clubbing provisions of the tax laws mean that income from such investments gets clubbed with my taxable income. Could you explain clubbing and how to avoid it?
Neeraj Goel

Gifts are a universal way to show love and affection to your family members and friends. The Indian government realised the merit of gifting, and stopped taxing gifts in 1998. No tax is to be paid on gifts while your loved ones enjoys the gift as well as the income from that gift.

Having said that, let me hasten to clarify that the above statement will not apply if the recipient happens to be your spouse. Interest or any other income, earned by your spouse from gifts is to be included in your income for tax purposes. Shocked? Bet you are. Paying taxes for someone else cannot be an expression of love or affection but the tax law does consider it so. The only exception is if you are separated from your spouse and the transfer is in connection with the agreement to live apart.

These measures have obviously been taken to stop tax evasion by falsely showing gifts. The transferor is liable to pay tax on income from the gift in the following situations:

l. Transfer of income without transfer of underlying asset. For instance, you are the owner of a house, which is rented out. You may arrange that the rent be paid to your spouse, parents or sister for their benefit, but the taxman will add the rent to your income and tax you on it as the asset is still owned by you.

2. Transfer of income producing assets is revocable within the lifetime of transferee. In the above example, you may transfer the house along with the income, but if this transfer is reversible, the income shall still be taxed as your income.

As always, the onus of satisfying the assessing officer on these counts is upon you. In addition, the following types of transactions will also attract clubbing. These are specific to your spouse and your daughter-in-law.

a). Income from assets transferred to daughter-in-law.
b). Income from assets transferred to any third person for benefit of spouse.
c). Income from any assets transferred to a third person for the benefit of daughter-in-law. Even the capital gains arising from sale of such gifted assets by the spouse get clubbed in your hands. (Dalmia vs CIT (1982) 133 ITR 169(Del).)

Here's how you can beat clubbing:
a). Gift to major son or daughter, or to son-in-law. Gifts to minors are always clubbed. Incidentally, this means that if you want to create wealth for your children, only gives them assets that will generate income after they turn major.
b) Gift to grandchildren.
c) Gifting away tax-free income bearing instruments such as RBI Bonds and other tax-free bonds.

Interestingly, investments from money received by the wife for household expenses are not clubbed as it is considered to be her income. If your wife's taxable income is lower than yours, give her money for household income and let her save out of it!

This article was originally published on November 21, 2002.