Death and payment of taxes are always painful. So, one question that goes through in the mind of every tax payer is “how can I minimize my tax liability?” Since, minimize tax liability is not always a bad or illegal exercise, unfortunate, there is also a tendency to reduce tax through malpractices or colourable methods. These are not acceptable by law and can pose multiple problems. Tax department not only imposes huge penalties but also initiate prosecution in such cases. So, there are legitimate many ways to minimize taxes through tax planning within the four corners of the law and such methods are always encouraged.
It is very common for people to receive gifts from friends and relatives. In some cases, gifts are also received from and given to their spouse as token of love and affection. Care should, however be taken to ensure that any gift which received or given should be a genuine and reasonable one. The person making the gift, called the donor, should have proof of his or her having the source for making the gift. Thus, spouse should not transfer any significant amount as gifts on the pretext on their birthdays and anniversaries in either ways; it would attract the provision of Section 64 and lead to clubbing of the spouse’s incomes, which are the most likely, not acquainted with.
In this cobra post, we would see all the aspects about these kinds of transactions, when any amount comes and goes out of your bank account on account of gift received and vice-versa and what are the implications for income tax on gifts received from their relatives in India.
Meaning of ‘Relative’
Firstly, it is imperative to know that the meaning of the expression ‘relative’ for this purpose. Section 56(2)(iv) provides that the expression ‘relatives’ means a gift received by an individual from his spouse, or from his brother or sister, or from the spouse’s brother or sister, parents, or from any lineal ascendant or descendant of oneself or one’s spouse would normally be fully tax-exempt. Similarly, any gifts of any amount whatsoever received from the spouse of any of these persons would also be completely exempt from income tax.
Example – If you receive a gift of Rs5 lakhs in cash from your maternal uncle, that is, your mother’s brother. You don’t need to worry about the taxation part, because it’s a gift from your relatives and you will not have to pay any tax on this amount, since the maternal uncle would be brother of the parent of the individual concerned and would come ambit the clause (iv) of the aforesaid Explanation.
Caution – Generally, gift made by way of cash or cheque does not mandatory requires to be executed through a gift deed. However, it’s a good practice to do the documentation for this, if the amount is pretty big like in this example. All you need to do is to document this transaction on a paper which clearly states that who transferred the money and the reason for it, along with the signatures of both parties. In future, if there is any income tax scrutiny, this small piece of proof will be handy and will help you a lot.
Cascading Effect – There is no income tax to be paid on the money received from relatives. But in case, if a husband gifts Rs10 lakhs to wife, there is no tax to be paid by wife on Rs10 lacs received, however when she invests that money and if any interest income is generated on the gifted amount, would attract the clubbing provisions under Section 64 which may apply and hence, it will be clubbed with husband income. Similarly, it would also apply the same provisions on son’s wife as the case may be.
Scrubbing the Clubbing Provision
There are many practical and lawful ways to overcome the clubbing provisions. Here, we have some thoughts which focus attention on scrubbing the clubbing provisions.
Gift to would-be spouse or Son’s would be Wife: While getting married, you must take advantage on the occasion of marriage is that any amount you get, as marriage gifts in cash or in kind are not taxable in your hands, either from relatives or non-relatives, irrespective of their value. But ensure that such gifts were made on the occasion of, but before the completion of the marriage rituals. These pre-marital gifts which would be outside the scope of the clubbing provisions as outlined above.
Gift to your Major Children: Any gift made to your minor child and that amount invested in his/her name, any generated income on that investment would be clubbed with you or your spouse’s income depending on whose total income is higher. However, this can be avoided by making the investment either in the name of major children or going to get mature at the time of maturity of investment.
Give Remuneration to Spouse: If your spouse is professionally or technically qualified, not necessarily relate to such qualification acquired by obtaining any certificates, diploma or degree etc, is paid reasonable remuneration for the genuine services rendered by him/her ,income from that remuneration would not attract any clubbing provisions under Section 64 of the Income Tax Act.
Advancing Interest Free Loan to Spouse: Any loan given to your spouse or child will not be deemed a case of transfer of income without transfer of assets which they can use to invest them self. All the income from those investments will not be clubbed in your income. Make sure that you have a documentary proof of Loan, A simple letter of Loan with Signatures of both the parties will be enough as Documentary Proof, no need to run for Lawyers for these.
Planning Exchange of Assets: Any transfer of asset is made without consideration, the question of clubbing of income would again arise. However, adequate consideration can be constructed as valuable consideration capable of being compared in money of money’s worth, if any individual transfers his income yielding assets to his spouse in the form of exchange of such assets, for assets which do not yield income and where the value of both such assets which are exchanged is equal, there would be no question of clubbing the income arising from such assets exchanged with the spouse. This point will be better understood from the following example.
Example – If, you exchange your fixed deposits of RS 1 lakh in a bank with your household articles worth Rs1 lakh belonging to your wife, from the date of exchange, your wife would start earning interest of Rs9,000 a simple calculated @ 9% p.a. on the above deposit of Rs1 lakh acquired by her. Reciprocally, your taxable income would stand effectively reduced under the above arrangement.
Investment of Gifted Funds in Tax-Free Investment: Any gifted fund must be invested in those instruments where its accrual incomes are tax free. They can invest in PPF, Tax free bonds or long term equity funds where its income is totally free from income-tax under Section 10 of the Income Tax Act. Income of such investments would enable the transferor to claim that no liability to income-tax would arise in this case.
Income from Accumulated Income of Gifted Assets: Building up income from accumulated income of gifted assets is not subject to be clubbing. Which means that if gift receiver continues to accumulate the income arising from such accumulated income, such further income is not liable for clubbing under Section 64. This can be illustrated as follows.
Example – If you give a gift worth Rs10 lakh to your wife and she invests the same in a FD bearing interest @ 8% p.a. and earns first year interest of Rs80,000 will be clubbed with the income of yours. Now, that this interest of Rs80,000 is accumulated and reinvested by her in similar FD and earns second year interest of Rs80,000 on FD of gifted amount of Rs10 lakh and Rs6,400 being interest on the accumulated amount of Rs80,000. Although the total income received by her is Rs86,400, of this, Rs80,000 would continue liable for clubbing in the income of yours, and income from accumulated interest of Rs6,400 would be treated as the separate income of your wife for tax purposes.
To undertake effective taxation planning via planning of gifts, one must know all cascading effect on the exemptions and deductions available presently under the Income Tax Act. Therefore, the optimization of taxes by systematic planning becomes very important and valuable function of the “Financial Planning Process”.
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