This article explains the concept of income clubbing. It shows how tax saving by investing in the name of family members may not save tax.

This article is a part of our detailed article series on the concept of gifting assets and investing in the name of your relatives. Ensure you have read the other parts here: Show/Hide

📚 Table of Contents

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• What is income clubbing?
• Clubbing provision depending on the type of transfer
• Husband to non-working wife
  • Case 1: FD interest or stock / MF dividends
  • Case 2: Selling Stocks or mutual funds
• Parents to children
  • If the children are minor
  • If the children are major
• Children to senior parents
  • Gifting and investing solely to evade taxes
  • Gifts become the property of the receiver

What is income clubbing?

Income clubbing is the rule that stops people from paying lower taxes by moving some income to someone else.

A good example is creating an FD in the name of a home-maker wife to save tax on the FD interest. In such cases, the interest income is added to the income of the husband, who gave the money for the FD to the wife and taxed it per the husband’s slab. This is called income clubbing, and in such a case, it does not save any tax.

Clubbing provision depending on the type of transfer

There are two types of income transfer:

• transfer of income but not the asset: this is the case where you allow, say, your child to receive the rent from a house that you own. Under Section 60 of the Income Tax Act, the income from that asset is clubbed with the transferor
• revocable transfer: this is the case where you gift an asset with the option of taking it back later. Under Section 61 of the Income Tax Act, the income from that asset is clubbed with the transferor

We will now discuss a few common and in no way comprehensive cases where income clubbing is applicable.

At this point, you should review the concept of gifting to relatives. In the case of gifts to siblings, spouses, parents and children, the gift itself might be tax-free, but income on the gift might get clubbed: Gift tax exemption rules: who can receive gifts that are tax-free?.

Husband to non-working wife

These examples also apply to a working wife investing in the name of a non-working husband.

Case 1: FD interest or stock / MF dividends

Say a husband gives 5 lakhs to his wife, who buys shares, invests in mutual funds or makes an FD. Interest from the FD or dividends from the shares will be added to the husband’s income.

Case 2: Selling Stocks or mutual funds

Capital gains (or losses) from selling the shares or mutual funds will also be taxed to the husband.

In both these cases, once the tax is paid on the income of the husband, any further tax from the residual income in the hand of the wife, when invested further, will not be clubbed with that of the husband.

Note: Any divorce settlement amount does not attract income clubbing since the spousal relationship no longer exists.

Parents to children

If the children are minor

Parents will have to pay taxes on any investment they make in the name of minor (i.e. younger than 18 years) children. This includes FD, shares, mutual funds, etc. Obviously, PPF is excluded since it is always tax-free.

If, however, the child has their self income, let’s say from a competition or shows or anything similar, then that income is not clubbed with the parent.

If the children are major

Income from investments, including capital gains, is not clubbed with that of the parents. This facility makes it more tax-efficient if the parents gift their adult children assets like mutual fund units, which the child then sells. The child, if they are in a lower tax bracket than the parent, pays lower capital gains tax.

Children to senior parents

It is standard for children to invest in the name of their senior citizen parents. There are two reasons here:

• the senior citizens get higher interest from FDs
• the parents are usually in a lower tax bracket compared to the child

Two caveats exist here that may not lead to tax saving or even getting back the entire money:

Gifting and investing solely to evade taxes

Suppose a son gifts ₹5 lakhs to his mother to make an FD in her name solely to save tax. In that case, the FD interest might get clubbed with the son if the mother returns the entire FD plus interest to the son on maturity. This rule exists to prevent tax evasion.

Gifts become the property of the receiver

Suppose a son, Amar, gifts ₹5 lakhs to his mother to make an FD in her name. This amount becomes the asset of the mother and may be claimed by the siblings of the son in case of the death of the mother. Since nominees are not legal heirs, even if Amar is the nominee in the FD, it does not automatically mean that only Amar gets the money later. His siblings might make a claim.

The parents also have the option of using these assets for expenses, like say a trip or an unexpected medical situation, for a sibling or anyone else for that matter.

We have discussed this topic in more detail here: Who should invest in the name of parents to save tax? Who should not?.