In this concluding article of the “Tax Implications on Gifts” series, we will understand how you can save more in taxes by gifting money to your family members. So far we have seen various tax implications on giving and receiving a gift and when the gifted money is further invested. In the previous article, we have seen a case where a husband had gifted money to his wife which she had invested in a bank FD and the interest thus earned on that FD was ultimately clubbed in the income of husband only; due to the clubbing provisions of the Income Tax Act.
Let’s understand how can you take advantage of the gifting provisions legally and what happens when the wife invests the gifted money in PPF or tax-free bonds or gift is made to one’s parents or major children.
What is Clubbing of Income?
Clubbing of Income is when the income of another person is included in the income of an Assessee. The income thus included in this scenario is called Deemed Income based on the various provisions as mentioned in Section 60 to 64 of the Income Tax Act. The idea behind introducing the clubbing provision is that no income should escape tax while moving assets or income to any third party including family members.
Clubbing of wife’s income
As seen so far; when a wife invests the gifted money and earns certain income from those investments, then the entire income would be clubbed in the hands of husband. But there is one more interesting angle to this in a case where the income earned is further reinvested?
Important Note: Income earned from the income earned is not clubbed!
Let’s consider another example where you invest Rs. 5 Lakhs in your wife’s name and earn an interest of Rs. 50,000. This Rs. 50,000 will be clubbed in your income for the computation of income tax; however, when your wife further invests this Rs. 50,000 in another FD and earns Rs. 5,000 (10% interest on Rs.50000) as interest on it, this interest will be considered as her own income only and will not be clubbed with your income.
Clubbing provisions will also not apply when the gifted money is invested in any investment option which are tax exempt, for e.g. in the above example let’s say rather than FD you would have invested the same Rs. 5 lakh for buying shares of a listed company in your wife’s name. You later sold the shares for Rs. 6 lakhs after holding it for a period of one year and earned a capital gain of Rs. 1 lakh which ultimately is tax free as long term capital gains are tax exempt.
Hence this Rs. 1 lakh capital gain income in your wife’s name will not be clubbed in your hand as either ways it is tax free and the earlier rule will also prevail when this gain of Rs. 1 lakh is further invested by your wife in any investment option and the income earned from it will always be clubbed in her name only.
Investing in your parents name
You can save taxes by gifting or giving loans to your parents or your in-laws as well because clubbing provisions does not apply in this case; the income on funds as gifted or loaned to them will be taxed in their hands only based on their income tax slabs.
For example you made a gift of Rs. 20 lakhs each to your mother and father who are senior citizens and they further invest this money say in a bank FD at an interest rate of say 10%; now both of them will get Rs 2 lakh as an interest income individually. If they are retired and not in receipt of any other income then this entire income which is less than the basic exemption limit of Rs.300000/- (as applicable to senior citizen) would be tax exempt and they even do not need to file their tax returns. If there is certain existing pension or other interest accruing to them presently then also it is always advantageous to gift them money and invest it in their name to enjoy the benefit of other tax exemptions and lower slab rate of taxes.
You can also buy a property in their name and put it on rent which again becomes tax free subject to their tax slab and other income accruing to them.
Through major children
Similar to the provisions as applicable to your parents, even money gifted and then invested in your children’s name who have attained the age of majority will not be clubbed in your hand.
In case where you have children who are 18 years or older and studying or earning at a lower tax slab than you then gifting your surplus money and investing in their name will neither attract gift tax nor clubbing. Income earned out of investments made by your major Children out of the gifts given by you will be taxed in their hands only.
You may even consider giving interest-free loans to your children as it is lawful and can help you save you more taxes. However when the children are minor then clubbing provision will attract except in cases where the income is earned by the child due to his or her skill or talent.
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