Does clubbing of income save tax?

A phone call between two friends leads to a conversation on the clubbing of income under the Income Tax Act. Those who have not yet filed tax returns for FY21, need to take note of these provisions.

Akhila: Hello! How’s life and work ?

Karthik: All well. I am trying to file my tax return and finish with this obligation by this weekend. I don’t want to wait till the extended December 31 deadline. You called me at the right time, actually. While it looks like I have no choice but to pay a fat tax this year, I was pondering over some ideas to save taxes in future.

Akhila: Is it? Shoot and let me tell you whether it will work or not.

Karthik: My total taxable income falls under the highest tax slab. I realised, just by excluding the interest income I earn on my fixed deposit from my total income, my tax slab can be a notch lower.

For this, I am planning to transfer this FD in the name of my kiddo now. Since he has no income, I can cut my tax outgo significantly from next year.

Akhila: Feel free to transfer the FD to your kid, by all means. But that will not reduce your tax burden. That interest income will continue to be taxable in your hands.

Karthik: Gosh!

Akhila: Thanks to genius tax planners like you, the Income Tax Act has an exclusive chapter that talks about clubbing of income.

Karthik: What genius? You just burst my bubble.

Akhila: Income earned by a minor child is clubbed with the income of the parent whose income is higher. Only if the minor child earns the income by way of manual work or application of his/her skill or talent, the clubbing will not come into picture. Since your kid won’t fulfil these conditions, the interest income will continue to be part of your taxable income or your wife’s.

Karthik: Uh, oh.

Can I at least transfer it in the name of my wife, who is currently earning lower than me, so that the tax will be a bit lower?

Akhila: Do you think the taxman wouldn’t have thought about it?

Karthik: Hmm…Of course, no. I was just trying my luck.

Akhila: Income from assets transferred to your wife, too, will be clubbed.

Karthik: Whoa! So basically, any income from assets transferred to my child or wife will be clubbed with my income, right? No escape route for me then...

Akhil: Mostly it does get clubbed in your hands, when the transfer is made without any consideration in return. This income has to be reported under Schedule SPI of the ITR.

Karthik: Got it.

Akhila: Remember, clubbing provisions will not apply on the income derived from clubbed income.

Karthik: Did you just utter a tongue twister?

Akhila: Ha-ha. Say, you transfer the FD to your son/wife. The interest income from that will be clubbed with your income. But if they invest the interest income somewhere, and your son/wife further earns an income from that, that income will not be clubbed with your income.

Karthik: Thank the taxman for small mercies.

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