Income clubbing: Are you trying to save tax by investing in the name of your parents or wife?
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 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:
This article discusses a common tax saving technique of investing in the name of parents to save tax. We also look at the pros and cons.
This article tells you who all can receive gifts of cash, shares, property or any other assets from you without paying any gift tax.
This article covers the mechanics for NRIs to regularly send or make one-time large gifts of money to parents in India.
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 husbandās slab. This is called income clubbing, and in such a case, it does not save any tax.
Join the Arthgyaan WhatsApp community: You can stay updated on our latest content and learn about our webinars. Our community is fully private so that no one, other than the admin, can see your name or number. Also, we will not spam you.There are two types of income transfer:
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?.
These examples also apply to a working wife investing in the name of a non-working husband.
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 husbandās income.
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 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, letās say from a competition or shows or anything similar, then that income is not clubbed with the parent.
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.
It is standard for children to invest in the name of their senior citizen parents. There are two reasons here:
Two caveats exist here that may not lead to tax saving or even getting back the entire money:
Suppose a son gifts ā¹5 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.
Suppose a son, Amar, gifts ā¹5 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?.
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This post titled Income clubbing: Are you trying to save tax by investing in the name of your parents or wife? first appeared on 12 Nov 2023 at https://arthgyaan.com