Income Tax: What Is 'Clubbing Of Income' And When Is It Necessary?

Most people try to find ways to reduce their tax burden, and some even transfer assets or income to their spouse or children, assuming it will help them save on taxes. However, the income tax department is one step ahead and has rules in place to prevent this. 

The Income Tax Act 1961, Section 60 to Section 64, has laid out the provisions for ‘clubbing of income’ which basically means that even if you shift income to another person, the tax liability still remains yours. 

What is Clubbing of Income as per Tax Laws?

A taxpayer has to club income when any source of income is earned by someone else (in the family), such as their spouse or child. The clubbing is done to compute the tax liability of an individual wherein the income earned by the other person is included (i.e. clubbed) in the taxable income of the taxpayer.

The rule ensures that people don’t avoid taxes by just shifting earnings to their family members.

Let’s understand this better with an example. Suppose you earn Rs 14 lakh a year, and you also own a property that gives you a rental income of Rs 2 lakh. If you decide to put this rental income in your wife’s name without actually transferring ownership of the property, thinking she will not have to pay tax on it, then think again. The tax department will still consider this ‘your income, and you will be taxed accordingly.

When Does Clubbing of Income Apply?

There are some common scenarios under which a taxpayer needs to club his income with that of a family member (spouse/minor child, etc.). These are;

1) Transfer of Income Without Transferring Asset

Under Section 60 of ITA, if a taxpayer gives someone the right to receive income from an asset (such as a house or shares) but has not transferred the ownership of that asset, then the income will still be taxable under their name.

For instance, you own a shop that gives you Rs 5 lakh per year in rent. The rent for this shop gets credited to your father’s account but you haven’t legally transferred the shop to him. In this case, the rental income will still be considered your income for tax purposes.

2) Revocable Transfers

Such kinds of transfers are referred to instances where an individual has given an asset to someone but it can be taken back whenever you want. Any income generated from such an asset will be taxable in the name of the original owner.

Here’s an example; You transfer a piece of land to your brother with an agreement that you can reclaim it after 5 years. Any income he earns from that land (like rent or profits from selling crops) will be added to your income, not his.

3) Income of a Spouse

Some taxpayers might think that they can save tax by showing income in their spouse’s name. However the ITA has stipulated some clear rules around this as well;

- If you transfer an income-generating asset to your spouse without proper compensation, any income from this asset will still remain taxable in your hands.

- If your spouse works in a company where you own any substantial stake (around 20 per cent or more), their salary could be clubbed with your income unless they have the necessary professional or technical qualifications for the said job/role.

Take this example; You gifted your wife Rs 5 lakh, and she invests it in a fixed deposit that earns interest of Rs XX amount per year. This interest amount will be taxable as your income, not hers.

The same rules apply if you transfer assets to your extended family members, say your daughter-in-law without proper compensation. Any income generated from this asset will be added to your income.

4) Income of Minor Children

Under Section 64(1A) of the ITA, if a minor child (below 18 years) earns any income, it is usually clubbed with the income of the parent who earns more. But this comes with a few exceptions, such as;

- If the child has a disability (as per Section 80U), this income will not clubbed

- If the child earns money using their own talent (such as singing, acting, writing, etc.), this income will too not be clubbed with your income.

- The parent can claim an exemption of Rs 1,500 per child under Section 10(32)  

For instance, if you invest Rs 5 lakh in your 10-year-old son’s name this investment earns you an interest per year, then this interest will be taxed as part of your income. (You may be able to claim an exemption for this under Section 10(32) subject to a few conditions.)

5) Income of a Hindu Undivided Family (HUF)

As per Section 64(2) of the ITA, if you transfer an asset to a HUF without proper consideration, then the income from that asset will be clubbed with your income.

Are There Exceptions to Clubbing Provisions?

Says CA Aastha Gupta, Partner, S.K.Gulati & Associates, “Clubbing does not apply if the transfer is made for adequate consideration or for business purposes.” Following are key exceptions to take note of;

- A minor’s self-earned income from skill or talent is exempt.

- Income from gifted assets is not clubbed if given to a major child, parents, or non-dependent relatives.

- Income from a transferred asset is not clubbed if the transferee reinvests the amount and earns further income (i.e., clubbing applies only to the first level of income).

How can you avoid unintended clubbing of income?

Gupta suggests the following ways that can help you with any unintentional clubbing of income;

- Make investments in the name of independent family members like major children or parents.

- Document transactions properly, ensuring they are at arm’s length and not structured solely to reduce tax liability.

- Opt for legitimate financial planning methods like gifting to parents, who fall in a lower tax slab, instead of a spouse or minor child.

Now, let’s review when exactly is the clubbing of income necessary.

Says Gupta, “Clubbing of income is mandated under Sections 60 to 64 of the ITA, 1961, to prevent tax evasion through asset transfers. It applies when a taxpayer transfers income or assets to specific relatives (spouse, minor child, son’s wife) without adequate consideration, yet continues to retain indirect benefits.” The common cases include income from assets gifted to a spouse or a minor child’s unearned income exceeding Rs 1,500 per year.

The primary reason for this rule is to prevent tax evasion, without which, some people might shift income to family members with lower tax slabs to avoid paying taxes.

If you’re considering transferring income or assets to a family member to reduce tax take note of the rules that apply to clubbing of such incomes and file your income tax returns accordingly.