How to Avoid Tax Traps by Understanding Clubbing of Income

Clubbing of income under Income Tax Act of India is a provision that combines the income of two or more persons for tax purposes. The purpose of clubbing is to prevent tax evasion by shifting income from one person to another who is in a lower tax bracket. Clubbing of income applies to individuals in certain situations, such as:

- When an individual transfers an asset to his or her spouse without adequate consideration, the income from such asset is clubbed with the income of the transferor. In such cases, the income arising from the transferred asset is clubbed with the income of the transferor spouse. For example, if A transfers a house property to his wife B without any consideration, then the rental income from that property will be clubbed with A's income and taxed accordingly. Another example is if A transfers a fixed deposit to his wife B without any consideration, then the interest income from that deposit will be clubbed with A's income and taxed accordingly.

- When an individual transfers an asset to his or her minor child (except a disabled child), the income from such asset is clubbed with the income of the parent whose total income is higher. In such cases, the income arising from the transferred asset or income is clubbed with the income of the parent whose total income (excluding the minor's income) is higher. The parent can claim an exemption of Rs 1,500 per minor child as per Section 10(32) of the Act. However, the clubbing provisions will not apply if the income is earned by the minor child's skills, knowledge, and experience. For example, if C transfers some shares to his minor son D without any consideration, then the dividend income from those shares will be clubbed with C's income and taxed accordingly. But if D earns income by writing a book or winning a competition, then that income will not be clubbed with C's income.

- When an individual invests in a firm or association of persons (AOP) in which he or she is a partner or member, and his or her spouse also invests in the same firm or AOP, the income from such investment is clubbed with the income of the spouse who has a higher share in the firm or AOP.

- When an individual receives income from assets transferred to a person for the benefit of his or her spouse or minor child, the income from such assets is clubbed with the income of the transferor.The provision may apply to various scenarios where assets are transferred to HUF.

These are some examples of clubbing of income under Income Tax Act of India. Clubbing of income has implications for tax planning and compliance for individuals and therefore one must consult tax professionals before executing such transactions.

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