A common situation faced by most tax advisers is where a taxpayer claims that certain income does not belong entirely to him due to the fact that the investment from which such income is received is held jointly with his wife or children. He, therefore, seeks to divide the income with other joint holders. On deeper probing, it becomes clear that the investment has been made entirely out of the taxpayer’s own funds and that the joint holder has not contributed anything to the cost of the investment. The taxpayer is generally disappointed to learn that in such a situation, his tax planning is of no avail and the entire income would be taxed in his hands alone, though the investment may be in joint names.
The Income-tax law in India recognises the concept of beneficial ownership as opposed to the concept of legal ownership. The legal owner is the person in whose name the asset is held, while the beneficial owner is one who is entitled to enjoy the asset as well as the income from the asset. It is the beneficial owner of the asset alone who is taxed in respect of the income from the asset. The normal principle is that in the case of joint holders, the share of each joint holder in an asset is determined by the ratio in which each joint holder has contributed towards the cost of the asset, unless there is evidence to the contrary. In case a joint holder has not contributed anything towards the cost of the asset, the normal presumption is that such a person is kept as a joint holder merely for convenience, so that in the event of the death of the joint holder, who is the beneficial owner, the asset can be easily transferred to the joint holder. So, the fact that a person is a joint owner of an asset does not mean that he is the beneficial owner of the asset nor that he would be taxed in respect of the income from the asset.
Of course, it is possible that the beneficial owner intended to gift a proportionate share of the asset to the joint holder and that is why the asset has been acquired in joint names. In such a situation, there would need to be evidence of such intention to gift a proportionate share to the joint holder. Such evidence could be in the form of a gift deed or a confirmation from the beneficial owner of the fact of such gift.
Of course, a gift to one’s spouse or children is not liable to income-tax even under the recently amended provisions under which tax gifts exceeding Rs50,000 will be treated as income of the recipient.
However, before you rush to gift your assets to your spouse or children to save your taxes, keep in mind that the tax laws will not let you off so easily. There are provisions for clubbing of income under the tax laws in respect of gifts made to your spouse and in respect of income of your minor children. So, if you make a gift to your spouse, the income on such assets will continue to be taxed in your hands indefinitely (or rather, for the term of your marriage). The only advantage is that when the spouse reinvests such clubbed income, the income arising out of such further investment is not clubbed. If you desire to make a gift to your spouse, she should invest such a gift in assets yielding tax-free income so that no taxable income would be added to your income. She can then build up her assets further out of such tax-free income without any impact of the clubbing provisions on you.
All income earned by your minor children is taxable in your hands unless the income was earned by your children as a result of their own manual efforts or skill, talent or specialized knowledge and experience. Making gifts to them would, therefore, not help you save any taxes. Of course, there are no clubbing provisions in respect of children who have attained the age of majority, or 18 years. You can certainly transfer a part of your assets to your adult children or children who will shortly cross the age of 18, and who may not have substantial income, to save on your taxes.
A note of warning—you may save your taxes but lose your assets. One hears of the classic tale of a bright young man who transferred his assets to his fiancée to avoid the clubbing provisions since he was advised that unless the relationship of husband and wife is in existence at the time of the gift, the clubbing provisions do not apply. When last heard of, this man was heard bemoaning his double loss due to the disappearance of both his fiancée and his assets. It is better to pay off one’s legitimate tax dues, rather than indulge in excessive tax planning.
Gautam Nayak is a chartered accountant. Your comments, questions and reactions to this column are welcome at firstname.lastname@example.org