Transferring money to your spouse may seem like a smart move to reduce your tax liability but the income tax law sees through it. For instance, if you transfer funds to your wife and she invests it in fixed deposits, , mutual funds or stocks, it may trigger clubbing provisions, where the income from those assets gets added back to your own taxable income.
Under Section 64 of the Income-tax Act, the clubbing provisions are meant to prevent taxpayers from reducing their tax liability by transferring assets or income to certain family members. Here’s how the clubbing rules work, when they apply and how can you plan your finances within the law.
How clubbing of income works if you transfer money to your wife?
Clubbing of income refers to the inclusion of another person’s income in your own in certain situations specified under Section 64 of the Income-tax Act. However, income of any and every person cannot be clubbed on a random basis while computing total income of an individual and also not all income of specified person can be clubbed.
As per Section 64, there are only certain specified income of specified persons which can be clubbed while computing total income of an individual.
If your spouse receives salary, commission, fees or any other form of remuneration from a concern in which you have a substantial interest, that income will be clubbed with the income of the spouse whose total income is higher (before clubbing), in accordance with Section 64(1)(ii).
However, there is an important exception. The clubbing provisions will not apply if your spouse possesses the necessary technical or professional qualifications in relation to any income arising to the spouse, and such income is solely attributable to the application of their own technical or professional knowledge and experience, according to a Cleartax report.
How to avoid clubbing of income ?
Here are some legal and practical ways taxpayers can plan around the clubbing provisions without violating the law. These include:
- Transferring money to parents and they invest it: If you give any amount to your parents and they invest it in, let’s say, a fixed deposit, then interest on such a FD will continue to be taxed in the hands of parents and clubbing provisions will not be applicable.
- Marriage gifts: Any money or assets given to someone during the time of their marriage will not be taxable in the hands of the giver or recipient. However if the recipient invests that money, then it will be taxed in the their hands as per applicable income tax rules.
- Investment in PPF: Since interest earned on is exempt from taxes, even if you invest in PPF in the name of your spouse or minor child , interest will remain tax-free. Since there is an investment cap of ₹1.5 lakh per individual in PPF , You can open multiple public provident fund accounts in the name of your spouse or minor child to get this benefit.