Many people transfer money to their spouse for savings or investments without realising it could have tax consequences. While gifting money to your husband or wife is allowed, the income generated from those funds may still be taxed in the hands of the person who transferred the money.
This is because of the clubbing of income provisions under the Income-tax Act, designed to prevent taxpayers from reducing their tax liability by shifting income to family members. Here's how the rule works and the situations in which it applies.
What is the clubbing of income?
Under Section 64 of the Income-tax Act, certain income earned by specified family members can be added, or clubbed, with the income of another taxpayer while calculating tax liability. The provision, though, does not apply to all family members or all types of income. It covers only specific situations mentioned under the law.
When does it apply to spouses?
If you transfer money to your spouse and that money is invested in fixed deposits, mutual funds, shares, gold or other assets, the income earned from those investments may be added to your taxable income.
The clubbing provision can also apply if your spouse receives salary, commission, fees or any other remuneration from a concern in which you have a substantial stake. According to Section 64(1)(ii), the income is generally clubbed with the income of the spouse whose total income is higher before clubbing.
Is there an exception?
Yes. The rule does not apply if your spouse has the required professional or technical qualifications and the income is earned solely through their own knowledge, skills or experience.
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How can you plan legally?
The Income-tax Act also provides certain situations where clubbing provisions do not apply:
Transfer money to parents: If you gift money to your parents and they invest it, the income earned from those investments will generally be taxed in their hands, not yours.
Marriage gifts: Money or assets received as gifts during marriage are not taxable in the hands of the giver or recipient. However, any income generated after investing those gifts will be taxed according to the applicable tax rules.
Invest in Public Provident Fund (PPF): Interest earned on PPF remains tax-free. If you invest in a PPF account opened in the name of your spouse or minor child, the interest continues to enjoy tax exemption, subject to the applicable investment limits.
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Conclusion
The clubbing provisions are intended to prevent tax avoidance through the transfer of income or assets within a family. Understanding these rules can help taxpayers plan their investments more effectively while making informed financial decisions.
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