The family route to save income tax
If you are resorting to roundabout ways to save tax, be careful not to rub the law the wrong way. The government has upped the ante against transactions intended at avoiding tax.
Buying an insurance policy in the name of your spouse or opening a fixed deposit in your child's name could be a genuinely emotional act. It could also be an attempt to save tax.
People often invest in relatives' name to save tax. Let's use an example to understand how one can transfer assets to someone within the family and save tax on income from those assets.
Mr Mukherjee, an advertising professional, sells a property owned by him and uses the money to open fixed deposits in his daughter and wife's name.
Mrs Mukherjee is a homemaker while the daughter is a trainee in a communications company. The daughter earns less than Rs 2 lakh a year and is out of the tax net. Mr Mukherjee is in the 30% tax slab. Can he escape paying tax on interest from these deposits? Not really.
The interest earned by Mr Mukherjee's wife will be clubbed with his income and taxed according to his income slab . However, the interest earned by the daughter will not be taxed in his hands.
Tapati Ghose, Partner, Deloitte Haskins & Sells, says, "Such gifts in excess of Rs 50,000 without consideration are generally taxed as income from other sources. However, tax laws make an exception in certain situations such as if the transfer is from a relative, under a will, inheritance or on occasion of marriage etc. While the gift to the daughter will not be taxed, the interest earned will be included in her income."
WAYS & MEANS
Most savings instruments allow investment in the name of spouse, children or parents, but with some restrictions. It is common to open a fixed deposit or buy insurance in the name of spouse or minor children. One can even open a Public Provident Fund (PPF) account or buy stocks in the name of spouse or children.
This can be done in two ways. One is joint holding, the first holder being the person in whose name you want to invest, or by transferring the amount/asset to the person who will make the investment. The person in whose name the investment is made (except minors) must comply with the know-your-customer (KYC) norms.
In joint holding, the person whose name appears in the application first must comply with the KYC norms. All correspondence will be addressed to him/her. Even cheques/drafts will be drawn in his/her name.
In case of minors, the person making the investment should comply with the KYC norms. Under KYC norms, a person has to furnish identity/address proofs and the Permanent Account Number issued by the income tax department.
CLUBBING OF INCOME
Any transfer of assets to close relatives (parent, spouse, sibling, lineal ascendant/descendant) is not taxed.
Many people use this rule to transfer assets to others who are either in a lower tax bracket or do not pay tax at all and save tax on income from these assets.
To check this, Section 64 of the Income Tax Act contains clubbing provisions as per which any income from investment made or assets purchased in the name of close relatives (spouse, minor child or daughter-in-law) is clubbed with the income of the person making the investment and taxed accordingly .
This applies to all types of investments such as shares, fixed deposits, land, building, post office savings and mutual funds.
Further, income from assets transferred directly or indirectly other than for adequate consideration to a person or association of persons who may benefit the individual's spouse or son's wife is also clubbed with the transferer's earnings.
So, if a person opens a fixed deposit in his wife or minor child's name, the interest earned will be clubbed with his income. Also, if a person buys a property in the name of his wife, who has not contributed any money, the rental income will be clubbed with his income.
However, if the spouse/relative has a source of income and has bought the asset through his/her own funds, the income will be taxed in his/her hands.
If the property is bought from funds contributed equally by both husband and wife, and is held jointly, the rental income will be split and taxed separately.
Even in case of minor child, "if the income is from the child's own skills, manual work, etc, such income will be directly taxed in the hands of the child. All other income will be clubbed in the parent's hands. The parent may claim an exemption of Rs 1,500 per minor child if the clubbing provisions come into play," says Ghose.
ALTERNATIVE WAYS
Despite the clubbing provisions, one can save tax legally by transferring assets to his/her spouse, parents or other relatives.
If a person is in the higher tax bracket than his wife, he can transfer a certain sum to his wife in exchange for her jewellery. She can open a fixed deposit so that the interest is taxed in her hands at a lower rate.
Similarly, if you transfer a house in your wife's name in exchange for her jewellery, the rental income will not be taxed in your hands.
Further, earnings from gift/transfer of an amount to a child who is not a minor will be taxed in the hands of the transferee. This is because the clubbing provisions will not be applicable in such cases.
Since the clubbing provisions do not apply to transfer of assets to parents or siblings, income from gratuitous payments to/investments in the name of parents for their maintenance can have an added advantage if the latter are in a lower tax slab.
THIRD-PARTY INVESTMENTS & I-T DEDUCTIONS
Under Section 80 C and Section 80 D of the Income Tax Act, investments in approved savings tools are eligible for income tax deduction.
While not all instruments allow tax deduction on investment in other's name, your contributions towards PPF, life insurance in your spouse/child's name and health insurance in your parents' name are eligible for income tax deduction.
"Investments made by an individual for his/her spouse or children are eligible for deduction if they are into life insurance and PPF," says Sreenivasulu Reddy, senior tax professional, Ernst & Young.
One can put money in PPF or Senior Citizens Savings Scheme (SCSS) in the name of spouse/parents and earn tax-free returns. If you have exhausted the Rs 1 lakh limit under PPF, you can gift money to spouse, parents, adult children or siblings, who can invest it in PPF. Though you won't be eligible for deduction in such cases, your money will earn a tax-free return of over 8% a year.
You can transfer surplus to your parents (above 60 years), who can in turn invest the same in SCSS, which is at present giving 9.3% annual return. Again, you cannot claim income tax deduction as this investment it is not in your name. But you can earn over 9% tax-free interest.
TREAD WITH CAUTION
If you are resorting to roundabout ways to save tax, be careful not to rub law the wrong way. The government has upped the ante against transactions intended at avoiding tax.
Nitin Baijal, director, BMR Advisor, says, "When you transfer money to someone in the lower tax bracket, you are essentially trying to avoid tax, and with all the talk on anti-avoidance, one should be careful while resorting to unlawful methods."
People often invest in relatives' name to save tax. Let's use an example to understand how one can transfer assets to someone within the family and save tax on income from those assets.
Mr Mukherjee, an advertising professional, sells a property owned by him and uses the money to open fixed deposits in his daughter and wife's name.
SPECIAL: Best investment tips to save tax
Mrs Mukherjee is a homemaker while the daughter is a trainee in a communications company. The daughter earns less than Rs 2 lakh a year and is out of the tax net. Mr Mukherjee is in the 30% tax slab. Can he escape paying tax on interest from these deposits? Not really.
The interest earned by Mr Mukherjee's wife will be clubbed with his income and taxed according to his income slab . However, the interest earned by the daughter will not be taxed in his hands.
Tapati Ghose, Partner, Deloitte Haskins & Sells, says, "Such gifts in excess of Rs 50,000 without consideration are generally taxed as income from other sources. However, tax laws make an exception in certain situations such as if the transfer is from a relative, under a will, inheritance or on occasion of marriage etc. While the gift to the daughter will not be taxed, the interest earned will be included in her income."
WAYS & MEANS
Most savings instruments allow investment in the name of spouse, children or parents, but with some restrictions. It is common to open a fixed deposit or buy insurance in the name of spouse or minor children. One can even open a Public Provident Fund (PPF) account or buy stocks in the name of spouse or children.
This can be done in two ways. One is joint holding, the first holder being the person in whose name you want to invest, or by transferring the amount/asset to the person who will make the investment. The person in whose name the investment is made (except minors) must comply with the know-your-customer (KYC) norms.
In joint holding, the person whose name appears in the application first must comply with the KYC norms. All correspondence will be addressed to him/her. Even cheques/drafts will be drawn in his/her name.
In case of minors, the person making the investment should comply with the KYC norms. Under KYC norms, a person has to furnish identity/address proofs and the Permanent Account Number issued by the income tax department.
CLUBBING OF INCOME
Any transfer of assets to close relatives (parent, spouse, sibling, lineal ascendant/descendant) is not taxed.
Many people use this rule to transfer assets to others who are either in a lower tax bracket or do not pay tax at all and save tax on income from these assets.
To check this, Section 64 of the Income Tax Act contains clubbing provisions as per which any income from investment made or assets purchased in the name of close relatives (spouse, minor child or daughter-in-law) is clubbed with the income of the person making the investment and taxed accordingly .
This applies to all types of investments such as shares, fixed deposits, land, building, post office savings and mutual funds.
Further, income from assets transferred directly or indirectly other than for adequate consideration to a person or association of persons who may benefit the individual's spouse or son's wife is also clubbed with the transferer's earnings.
So, if a person opens a fixed deposit in his wife or minor child's name, the interest earned will be clubbed with his income. Also, if a person buys a property in the name of his wife, who has not contributed any money, the rental income will be clubbed with his income.
However, if the spouse/relative has a source of income and has bought the asset through his/her own funds, the income will be taxed in his/her hands.
If the property is bought from funds contributed equally by both husband and wife, and is held jointly, the rental income will be split and taxed separately.
Even in case of minor child, "if the income is from the child's own skills, manual work, etc, such income will be directly taxed in the hands of the child. All other income will be clubbed in the parent's hands. The parent may claim an exemption of Rs 1,500 per minor child if the clubbing provisions come into play," says Ghose.
ALTERNATIVE WAYS
Despite the clubbing provisions, one can save tax legally by transferring assets to his/her spouse, parents or other relatives.
If a person is in the higher tax bracket than his wife, he can transfer a certain sum to his wife in exchange for her jewellery. She can open a fixed deposit so that the interest is taxed in her hands at a lower rate.
Similarly, if you transfer a house in your wife's name in exchange for her jewellery, the rental income will not be taxed in your hands.
Further, earnings from gift/transfer of an amount to a child who is not a minor will be taxed in the hands of the transferee. This is because the clubbing provisions will not be applicable in such cases.
Since the clubbing provisions do not apply to transfer of assets to parents or siblings, income from gratuitous payments to/investments in the name of parents for their maintenance can have an added advantage if the latter are in a lower tax slab.
THIRD-PARTY INVESTMENTS & I-T DEDUCTIONS
Under Section 80 C and Section 80 D of the Income Tax Act, investments in approved savings tools are eligible for income tax deduction.
While not all instruments allow tax deduction on investment in other's name, your contributions towards PPF, life insurance in your spouse/child's name and health insurance in your parents' name are eligible for income tax deduction.
"Investments made by an individual for his/her spouse or children are eligible for deduction if they are into life insurance and PPF," says Sreenivasulu Reddy, senior tax professional, Ernst & Young.
One can put money in PPF or Senior Citizens Savings Scheme (SCSS) in the name of spouse/parents and earn tax-free returns. If you have exhausted the Rs 1 lakh limit under PPF, you can gift money to spouse, parents, adult children or siblings, who can invest it in PPF. Though you won't be eligible for deduction in such cases, your money will earn a tax-free return of over 8% a year.
You can transfer surplus to your parents (above 60 years), who can in turn invest the same in SCSS, which is at present giving 9.3% annual return. Again, you cannot claim income tax deduction as this investment it is not in your name. But you can earn over 9% tax-free interest.
TREAD WITH CAUTION
If you are resorting to roundabout ways to save tax, be careful not to rub law the wrong way. The government has upped the ante against transactions intended at avoiding tax.
Nitin Baijal, director, BMR Advisor, says, "When you transfer money to someone in the lower tax bracket, you are essentially trying to avoid tax, and with all the talk on anti-avoidance, one should be careful while resorting to unlawful methods."
