Mukesh Patel.in
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ESCAPE THE TAX AXE & RELAX!

Income from gift to your spouse is liable to be clubbed with your income but you can surely plan lawful circumvention!

    Section 64(1) of the Income-tax Act provides that in computing the total income of an individual, the income arising to the spouse from assets gifted by an individual would be clubbed with the total income of the individual. Similarly Section 4 of the Wealth-tax Act also provides for inclusion of such gifted assets by the individual to the spouse in the computation of net wealth.

Are there any practical and lawful ways to overcome the clubbing provisions? This is a common question that would naturally arise in the context of the provisions of Section 64 of the Income-tax Act and Section 4 of the Wealth-tax Act referred to above. Discussed below are some thoughts which focus attention on scrubbing the clubbing provisions.

PLANNING EXCHANGE OF ASSETS

The question of clubbing of income under Section 64 would arise only in those cases where the transfer of the asset is made without consideration. Where, however, the transfer is made for valid consideration which is adequate, there can be no question of clubbing of income. Adequate consideration must be construed as valuable consideration capable of being compared in money or money’s worth. Moreover, the adequacy of consideration is to be examined with relevance to the date of transfer and not at any earlier or later point of time.

Keeping this in mind, if an individual transfers his income yielding assets to his spouse in the form of exchange of such assets, for assets which do not yield income and where the value of both such assets which are exchanged is equal, there would be no question of clubbing the income arising from such assets exchanged with the spouse. This point will be better understood from the Illustration below:

Illustration: Mr. M exchanges his fixed deposit in a company of Rs.5,00,000 with household articles worth Rs.5,00,000 belonging to his wife, Mrs. M. From the date of exchange, Mrs. M would start earning interest of Rs.50,000 calculated @ 10% p.a. on the above deposit of Rs.5,00,000 acquired by her. Reciprocally, Mr. M’s taxable income would stand effectively reduced under the above arrangement.

Since the transfer in the form of exchange of assets in the above case has taken place for adequate consideration, the income arising to Mrs. M would not be liable to be clubbed with the income of Mr. M. In the above illustration, the exchange of fixed deposit against household articles, which being in the nature of ‘personal effects’ and not ‘a capital asset’, does not attract any liability to capital gains tax. However, where there is a transfer of ‘a capital asset’ at an appreciated value, suitable planning must be considered to avoid or reduce the liability of tax on capital gains.

INVESTING IN TAX-FREE INVESTMENTS

The impact of the clubbing provisions under Section 64 can be effectively blunted by investing the gifted funds in such investments, the income of which is totally free from income-tax under Section 10 of the Income-tax Act. Tax-free investments of this type would enable the transferor to claim that no liability to income-tax would arise in his case on income from such investments, notwithstanding the fact that such investments have been made by the transferee spouse or son’s wife out of the funds gifted by the transferor. Moreover, the accumulated income from such tax-free investments can be reinvested in taxable investments as per the planning suggested earlier, since such ‘income from accumulated income’ would be outside the purview of Section 64 of the Income-tax Act. This point will be well appreciated from the Illustration given below:

Illustration: Mr. P gives a gift of Rs.10,00,000 to his wife Mrs. P. Mrs. P invests the same in a debt-based Mutual Fund yielding 7% annual dividend. At the end of the first year, the interest of Rs.70,000 received by Mrs. P on the gifted amount of Rs.10,00,000 would not attract the clubbing provisions, since the said income would be totally exempt under Section 10(35) of the Income-tax Act. If the tax free interest of Rs.70,000 is invested by Mrs. P in a private deposit bearing 12% interest per annum, for the second year, the interest received by her would be Rs.70,000 on the gifted amount of Rs.10,00,000 invested in the Mutual Fund and Rs.8,400 being interest on the amount of Rs.70,000 invested in the private deposit.

For the second year, the income of Rs.70,000 would be exempt under Section 10(35) and income of Rs.8,400 representing ‘income from accumulated income’ would be outside the scope of Section 64 and hence not liable for clubbing with the income of her husband. The same position can be continued in the subsequent years and by playing smart, the clubbing provisions can be lawfully avoided.

 

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