Monday, June 16, 2014

TAX NOTES: CLUBBING OF INCOME UNDER INCOME TAX


Certain provisions are included in the act as anti tax avoidance measures. Provisions for inclusion in assessee’s income, income of some other person, which is not at arm’s length, are a kind of such provisions. Such provisions arrest tax leakage likely to result from certain transactions with relatives or diversion of title without losing control over the same, etc.

ENCOMPASS OF CLUBBING PROVISIONS
  1. Clubbing of income where control over assets or income is retained while title is transferred: Sections 60, 61,64(1)(iv),(vi),(vii),(viii)
  2. Clubbing of income of relatives under certain circumstances:   Sections 64(ii)
  3. Clubbing of income of minor child:   Section 64(1A)
TRANSFER OF ASSETS [ Sec. 60]
Where any person transfers income without transferring the ownership of the asset, such income is taxable in the hands of the transferor. Such transfer may be revocable or irrevocable. The provision applies irrespective of the time when the transfer has been made i.e. it may be before or after the commencement of the Income-tax Act.

REVOCABLE TRANSFER OF ASSETS [Sec. 61]
Any income arising to any person by virtue of revocable transfer of assets is chargeable to tax as the income of transferor. For this purpose, transfer may include any settlement or agreement.

The transfer is said to be revocable if it contains any provision for the re-transfer of the whole or any part of the income or assets to the transferor or a right to re-assume power over the whole or any part of the income or assets.

If any settlement contains a clause for forfeiture of rights of beneficiaries under certain circumstances, the settlement will be regarded as revocable – CIT vs. Bhubaneshwar Kuer 53 ITR 195 (SC).

IRREVOCABLE TRANSFER OF ASSETS FOR SPECIFIED PERIOD [Sec. 62]
(1) The provisions of Section 61 shall not apply to any income arising to any person by virtue of a transfer —
  • by way of trust which is not revocable during the lifetime of the beneficiary, and, in the case of any other transfer, which is not revocable during the lifetime of the transferee ; or
  • made before the 1st day of April, 1961, which is not revocable for a period exceeding six years. Provided that the transferor derives no direct or indirect benefit from such income in either case.
(2) Notwithstanding anything contained in Sub-section (1), all income arising to any person by virtue of any such transfer shall be chargeable to Income-tax as the income of the transferor as and when the power to revoke the transfer arises, and shall then be included in his total income.

TRANSFER AND REVOCABLE TRANSFER DEFINED UNDER SECTION 63
For the purposes of sections 60, 61 and 62 and of this section,—
 
(a) A transfer shall be deemed to be revocable if—
  • It contains any provision for the re-transfer directly or indirectly of the whole or any part of the income or assets to the transferor, or
  • It, in any way, gives the transferor a right to re-assume power directly or indirectly over the whole or any part of the income or assets ;
(b) “Transfer” includes any settlement, trust, covenant, agreement or arrangement.

REMUNERATION OF SPOUSE [Sec. 64(1)(ii)]
An individual assessee is chargeable to tax in respect of any remuneration received by the spouse
from a concern in which the individual has substantial interest. However, remuneration, which is solely attributable to technical or professional knowledge and experience of the spouse, will not be clubbed.Where both the spouses have a substantial interest in the concern and both are in receipt of the remuneration for such concern, such remuneration will be included in the total income of the husband or wife whose total income excluding such remuneration is greater.

The individual is deemed to have substantial interest, if the beneficiary holds equity share carrying not less than 20% voting power in the case of a company or is entitled to not less than 20% of the profits, in any other concern, not being a company at any time during the Previous Year.

INCOME FROM ASSETS TO SPOUSE [Sec. 64(1)(iv)]
Where an asset (other than house property) is transferred by an individual to his or her spouse directly or indirectly otherwise than for adequate consideration or in connection with an agreement to live apart any income from such asset will be deemed to be the income of transferor.
 
However, this section is not applicable in the following cases

(a) if assets are transferred before marriage.
(b) if assets are transferred for adequate consideration.
(c) if assets are transferred in connection with an agreement to live apart.
(d) if on the date of accrual of income, the transferee is not spouse of the transferor.
(e) if property is transferred by the Karta of HUF, gifting co-parcenary property to his wife.
(f) the property is acquired by the spouse out of the pin money (i.e., an allowance given to the wife
by her husband for her dress and usual household expenses).

INCOME FROM ASSETS TRANSFERRED TO SON’S WIFE OR MINOR CHILD [Sec. 64(1)(vi)]
If an individual directly or indirectly transfers the assets after 1.6.73 without adequate consideration to son’s wife or son’s minor child (including son’s minor step child or son’s minor adopted child), income arising from such assets will be included in the total income of the transferor from the Assessment Year 1976-77 onwards.

INCOME FROM ASSETS TRANSFERRED TO A PERSON FOR THE BENEFIT OF SPOUSE OR MINOR CHILD [Sec.64(1)(vii)]
Where an asset is transferred by individual, directly or indirectly, without adequate consideration to a person or persons for the immediate or deferred benefits of his or her spouse or minor child, income arising from the transferred assets will be included in the total income of the transferor to the extent of such benefit. If no income is accrued out of the property transferred by an individual, then nothing will be included in the income of the individual.

INCOME FROM ASSET TRANSFERRED TO A PERSON FOR THE BENEFIT OF SON’S WIFE [Sec. 64 (1)(viii)]
Where an asset is transferred by an individual, directly or indirectly, or after 1.6.73 without adequate
consideration to a person or an Association of Persons for the immediate or deferred benefits of son’s
wife, income arising directly or indirectly from transferred asset will be included in the total income of the transferor to the extent of such benefit with effect from the Assessment Year 1985-86.

INCOME OF MINOR CHILD [Sec. 64(1A)]
In computing the total income of any individual, there shall be included all such income as arises or
accrues to his minor child. However, income of the following types will not be included in the total
income of the individual where income arises or accrues to the minor child on account of any—
(a) manual work done by him; or
(b) activity involving application of his skill, talent or specialised knowledge and experience.

Person in whose hands to be clubbed :
(i) 1st year : that parent whose income is higher. Subsequent years : the same parent – unless the AO is satisfied that it should be clubbed with the other parent.
(ii) Where marriage does not subsist, in the hands of the custodian parent.

However, a deduction — Upto INR. 1,500 per minor child [Sec. 10(32)] shall be allowed against such income which is clubbed in the hands of the parent.

CONVERSION OF SELF-ACQUIRED PROPERTY INTO JOINT FAMILY AND SUBSEQUENT PARTITION [Sec. 64(2)]
Where a member of a HUF has converted his self-acquired property into joint family property after
21.12.1969, income arising from the converted property will be dealt with as follows :-

(i) For the Assessment Year 1976-77 onwards, the entire income from the converted property is
taxable as the income of the transferor.
(ii) If the converted property is subsequently partitioned amongst the members of the family, the
income derived from such converted property, as is receivable by the spouse and minor child of
the transferor will be taxable in his hands.

INCOME FROM THE ACCRETION TO ASSETS

In the above mentioned cases the income arising to the transferee from the property transferred, is taxable in the hands of the transferor. However, income arising to the transferee from the accretion of such property or from the accumulated income of such property is not includible in the total income of the transferor. Thus, if Mr. A transfers ` 60,000 to his wife without any adequate consideration and Mrs. A deposits the money in a bank, the interest received from the bank on such deposits is taxable in the hands of Mr. A. If, however, Mrs. A purchases shares in a company from the accumulated interest, the dividend received by Mrs. A, will be taxable in her hands and will not be clubbed with the income of  Mr. A.

CLUBBING OF NEGATIVE INCOME [EXPLANATION TO Sec. 64]
The income of a specified person is liable to be included in the total income of the individual in the
circumstances mentioned earlier. For the purposes of including income of the specified person in the income of the individual, the word “income” includes a loss.

RECOVERY OF TAX u/s. 60 TO 64 [Sec. 65]
As per incomes belonging to Sec.s 60 to 64 to other persons are included in the total income of the
assessee in such cases, by virtue of sec. 65, the actual recipient of income is liable, on the service
of notice of demand, to pay the tax assessed in respect of income included in the income of other
person (where the Income Tax Officer so desires).

ILLUSTRATIONS ON CLUBBING OF INCOME
Illustration 1. Mrs.G holds 7% equity shares in B Ltd., where her married sister, Mrs. N also holds 14% equity shares. Mr.G is employed with B Ltd., without holding technical professional qualification. The particulars of their income for the Previous Year 2013-2014 are given as follows:


Note:
  1. In the instant case, Mrs. G along with his sister, holds substantial interest in B Ltd. and Mr. G does not hold professional qualification. Accordingly, remuneration of Mr.G has been included in the total income of Mrs. G.
  2. If the requisite conditions of clubbing are satisfied, clubbing provision will apply even if their application results into lower incidence of tax.
Illustration 2. Mrs. C, a law graduate, is legal advisor of L Ltd. She gets salary of ` 1,80,000. Mr. C is holding 20% shares in L Ltd. His income from business, during the Previous Year 2013-2014 is INR. 4,00,000. Compute their Total Income.
Solution : Computation of Total Income of Mr. C & Mrs. C for the A.Y. 2014-2015


Note: Since Mrs. C holds professional qualification, salary income is assessable in her hands.
Illustration 3. Mr. B holds 5% shares in A Ltd., where his brother and nephew hold 11% and 6% shares, respectively. Mrs. B gets commission of INR.1,00,000 from A Ltd. for canvassing orders. She holds no technical/professional qualification. Mr. B earns income of  INR. 5,00,000 from sugar business.
 
Compute their Total Income for the Assessment Year 2014-15.

Solution : Computation of Total Income for the AY 2014-15

Note: In the instant case, Mr. B holds 5% and his brother holds only 11% shares in A Ltd. The total of their shareholding is less than 20%. They have no substantial interest.
 
Therefore, commission income is assessable as income of Mrs. B.

Illustratio 4. The shareholding of Mr. K and Mrs. K in S Ltd, is given as follows:
(i) Shareholding of K: 7%
(ii) Shareholding of Mrs. K: 9%
(iii) Shareholding of M, brother of K: 8%
(iv) Shareholding of F, father of Mrs. K: 5%
Mr. K and Mrs. K are employed with S Ltd. None of them hold technical
qualification. Mr. K gets salary @ INR. 10,000 p.m and Mrs. K gets @ INR. 12,000 p.m.
Income from Other Sources: 

Mr. K : INR. 80,000
Mrs. K INR. 1,00,000

Compute total income for the Assessment Year 2014-2015
Solution : Computation of Total Income for the A.Y. 2014-15
 

Illustration 5. Mr. A gifts INR. 4,00,000 to Mrs. A on 1st February 2014. Mrs. A starts crockery business and invests INR. 1,00,000 from her account also. She earns profit of INR. 60,000 during the period ending on 31 March 2014. How would you tax the business profits?

Solution : Proportionate profits, in proportion to the gifted amount from the spouse on the first day of
the Previous Year bears to the total investment in the business on the first day of the Previous Year, will be taxable in the income of the transferor spouse.
 
As Mrs. A has started the new business, the first Previous Year will begin on the date of setting up and will end on 31st March, immediately following. Thus, the first Previous Year will consist a period of 2 months from 1st February 2014 to 31st March, 2014. Therefore, proportionate profit of ` 48,000, computed as below, will be included in the income of Mr. A:

4,00,000
5,00,000   ×  60,000 = 48,000

Illustration 6. Mr. A gifts ` 3,00,000 to Mrs. A on 1st February 2014. Mrs. A invests the same in the existing crockery business where she has already invested ` 5,00,000. Mrs. A earns ` 3,00,000 from the business during the year 2013-2014 ending on 31st March, 2014. How would you assess the profits?

Solution : The Previous Year of the existing business is April to March. On the first day of the Previous Year (i.e. 1 April 2013), total investment has come from Mrs. A account. As the proportion of the gifted amount from spouse on 1 April 2013 to the total investment in business on the same day is NIL, the whole of the profits of ` 3,00,000 for the year 2013-2014 will be included in the total income of Mrs A. 
From the Previous Year 2014-2015, 60% [= 3,00,000/5,00,000 × 100] of the business profits will be included in the total income of Mr. A. 

Illustration 7. Mrs. Z is the owner of the business units A and B. A unit has been started with capital
contribution from Mr. Z and B unit has been started out of capital contribution from Mrs. Z. The particulars of their income for the Previous Year 2013-2014 are as follows:
 

How would you assess them for the Assessment Year 2014-2015 ?
 
Solution :
(a) Mrs. Z is assessable on the profits from B unit. She cannot set-off the loss from A unit against the
profits of B unit. Thus, she would be assessed on INR. 4,00,000.
(b) The loss from A unit will be included in the total income of Mr Z in view of Sec. 64(1)(iv). “Income” includes “loss” also. Mr Z is entitled to set-off business loss of A’s unit against Income from House Property. Thus, loss of  INR. 3,50,000 would be carried forward but could be set-off only against business profits.

Illustration 8. Mr. Goutam, out of his own funds, had taken a FDR for INR.1,00,000 bearing interest @ 10% p.a. payable half-yearly in the name of his wife Latika. The interest earned for the year 2013-2014 of  INR. 10,000, was invested by Mrs. Latika in the business of packed spices which resulted in a net profit of INR.55,000 for the year ended 31st March, 2014. How shall the interest on FDR and income from business be taxed for the Assessment Year 2014-2015?

Solution : Where an individual transfers an asset (excluding house property), directly or indirectly to his/her spouse, otherwise than for adequate consideration, or in connection with an agreement to live apart, income from such asset is included in the total income of such individual [Sec. 64(1)(iv)].

Accordingly, interest on FDR, accruing to wife, is included in the total income of her husband. However, business profits cannot be clubbed with total income of husband. Clubbing applies only to the income from assets transferred without adequate consideration. It does not apply to the income from accretion of the transferred assets. Hence, business profit is taxable as the income of wife.

Illustratio 9: Sawant is a fashion designer having lucrative business. His wife is a model. Sawant pays her a monthly salary of ` 20,000. The Assessing Officer, while admitting that the salary is an admissible deduction, in computing the total income of Sawant, had applied the provisions of Sec. 64(1) and had clubbed the income (salary) of his wife in Sawant’s hands. 

Discuss the correctness of the action of the Assessing Officer. 

Solution: Where an individual has got substantial interest in a concern and his spouse derives any
income from such concern by way of salary, commission, fees or by any other mode, such income is
clubbed with the total income of such individual [Sec. 64(1)(ii)].

However, clubbing provision does not apply if the earning spouse holds technical or professional
qualification and the income is solely attributable to the application of such knowledge and experience.

Salary earned by wife as model from the concern where her husband holds substantial interest is
assessable as her income.

Illustration 10. Discuss whether the loss could be set-off in the following case:
Smt. Vatika carried on business with the gifted funds of her husband Mr. Dabbu. For the Previous Year ending 31.3.2014, Vatika incurred loss of ` 5 lakh which Dabbu wants to set-off from his taxable income.

Solution : Funds for business were gifted by husband to wife. Accordingly, income from business should be clubbed with the income of husband [Sec. 64(1)(iv)].
 
“Income” includes “loss” also. Hence, husband is entitled to set-off the business loss of wife against his taxable income.

FAQ

CLUBBING THE INCOME OF SPOUSE & MINOR CHILD
A Salary-earner (and other individual tax payers too) generally do not include specified income of their spouses and minor-children, while filing their own income-tax returns.

Starting from Assessment Year 1993-94 all incomes arising or accruing to minor children are to be included in the total income of that parent whose total income (before such inclusion) is greater. The word used is 'all income' but any income arising to the minor child as a result of some manual-work done by him or from such activity involving application of his skill, talent or specialised knowledge and experience is not to be included in the hands of the parents. For example, income of a child actor or singer derived from acting or singing is not covered by this clubbing provision.

IF THE PARENTS ARE DIVORCED OR LEGALLY SEPARATED, IN WHOSE HANDS IS THE INCOME OF THEIR MINOR-CHILD TO BE INCLUDED?
In such cases, the income arising to the minor-child will be assessed in the hands of that parent who maintains the minor-child in that year.

IF IN ANY SUBSEQUENT YEAR THE INCOME OF THE OTHER PARENT BECOMES GREATER, WILL THE INCOME OF THE MINOR-CHILD CONTINUE TO BE ASSESSED IN THE HANDS IT WAS FIRST ASSESSED?
No. It has to be assessed in the hands of the parent whose total income is greater. However, his Assessing Officer has to first give him/her a notice informing him/her that for that year the minor-child's income has
  • to be included in his/her hands as he/she has greater
  • total income than his/her spouse.
IF THE ASSETS ARE BOUGHT BY THE MINOR CHILD OUR OF GIFTS RECEIVED ON HIS BIRTHDAY, IS THEIR INCOME TO  BE  CLUBBED  IN THE  HANDS  OF  HIS PARENTS?
Yes. The law requires it.

IS THERE AN EXEMPTION LIMIT FOR CLUBBING OF MINOR CHILD'S INCOME IN THE HANDS OF AN INDIVIDUAL?
Yes. The exemption limit is Rs.1500 per child in a year.

CLUBBING OF OTHER INCOMES
Besides clubbing of income of minor-children in the hands of the parent, certain other incomes are also liable to be clubbed in the hands of the individual in the following circumstances:-
  1. When   the  income  arises  to  the   spouse   of such individual from assets transferred directly or indirectly to the spouse by the individual for inadequate consideration.
  2. When the income arises to the son's wife from assets, transferred after 1st June 1973, to the son's wife by the individual for inadequate consideration.
  3. When income arises to the son's wife from assets transferred, for    inadequate consideration, by the individual to such person for the benefit of   the individual's wife or son's wife.
IS INCOME FROM 'SHARES' BOUGHT BY AN INDIVIDUAL OUT OF HIS OWN FUNDS BUT INVESTED IN THE NAME OF HIS WIFE, TO BE TAXED IN HIS HANDS?
Yes. Certainly, if the funds were transferred for inadequate consideration.

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