 "Ease your family's tax burden by gifting, clubbing income")
When Rohit Khanna got married, he and his wife Sonali received a sizeable amount of cash as gift. They wanted to invest the money in bank Fixed Deposits. But the interest would be taxed and since Khanna falls in the highest tax bracket, the net return from the FD will be quite less. Being a conservative investor, Khanna does not want to invest in equity products. The tax on debt mutual funds is also proving to be a dampener.
How can Khanna minimise taxes, yet get safe returns? For many people tax planning is related to only making investments under Section 80C. But there are different provisions in the Income Tax Act which, if used judiciously, may help in considerable tax saving. Some of those provisions may apply in this case.
Spreading of income and creating different tax files using gift and settlement provisions is an effective way of tax planning. It is always wise to have tax files of all family members. This may not reduce the tax outgo from the salary or business income, but it will surely help in reducing the taxes to be paid on income generated from investments. Having different tax files leads to usage of basic exemption limits and also in taking benefit of the available tax deduction benefits. These are legal provisions and will not get you in trouble with tax authorities. But be prepared for some amount of additional paperwork.
Gifts received at wedding
For instance, in the example mentioned above, the wedding gifts can be accounted for in the name of Sonali, who is a home maker. As per the gift tax provisions, any gifts received by bride or groom, excluding the gifts received by son-in-law from parents- in-law, is tax free in the hands of receiver. A new tax file in the name of the bride can be created and gift money can be invested in her name to reduce the family's tax burden.
Receiving wedding gifts in the name of bride/daughter-in-law is legal. In this case, when Sonali files taxes, she can take benefit of the basic exemption limit of Rs 2.5 lakh. If her annual income exceeds this limit, she can invest up to Rs 1.5 lakh in specified instruments and claim tax exemption under Section 80 C. Some of these instruments are Public Provident Fund, tax-saver bank FDs, Equity Linked Savings Schemes, National Savings Certificates, life insurance policies. This means that, Rohit and Sonali can enjoy up to Rs 4 lakh tax-free income, in Sonali's name. Even if the income generated exceeds Rs 4 lakh, Sonali will still be in the lowest tax-bracket, and her tax liability will be much lower than that of Rohit.
One thing to note here is that this kind of transaction can help only at the time of the wedding. After that, once the relationship is established as daughter-in-law, if parents-in-law or even the husband want to gift or invest any amount in her name, then though the amount received by the wife will be tax free, the returns generated out of that amount will be clubbed in the income of the transferor.
But any gift received from her parents or her siblings will be tax free and investments out of that will be taxed in her name, not the transferor's name.
Clubbing provisions
Gift tax provisions should always be seen in conjunction with the clubbing provisions as laid down under Section 60-64 of I-T Act. These sections deal with the cases where taxpayer uses the gifting process as a means of transferring the tax incidence on other person, but actually the income is being enjoyed by the transferor.
As per gift tax provisions, gifts received from blood relatives (spouse, parents, your and spouses' siblings, maternal or paternal aunts and uncles and their spouses, brothers-in-law and sisters-in-law), or on the occasion of wedding and also as inheritance through Will, will be tax-free in the hands of receiver. But clubbing provisions have laid down few instances where the income generated from the gift or transferred income will be clubbed back in the income of transferor. Some of the instances are investing in the name of non-earning spouse or daughter-in-law, or in the name of minor children.
Income in the name of minor child
Income generated in the name of minor child is exempt only up to Rs 1,500 per month. Any amount over and above this will be clubbed in the income of the parent whose income is higher. But if someone wants to build a tax file in the name of the minor child and invest in taxable instruments, then he can avoid clubbing by creating a 100 per cent specific beneficiary trust, with a special mention of deferment of the benefit during the minority of the minor child, that means till the child turns 18 years. This will ensure that any income generated by this trust will be taxable at the trust level and the benefit of basic exemption limit and tax deductions can be availed of. Taxation is same as for individuals. so, the family can avail of an additional Rs 2.5 lakh exemption in the name of the trust.
Income received by HUF
Tax-payers who are Hindus can also take help of the Hindu Undivided Family (HUF), which is recognised as a separate entity for taxation purposes. One may also form an HUF and gradually build a tax file in that name, by receiving gifts from relatives. Provisions of gift tax do apply here, but clubbing only gets attracted where gifts are given by HUF members.
Investments in the name of child
While saving for child's future, generally one invests in equity related tax-free instruments in the initial years and later on moves to safer taxable instruments. By the time child enters college, she will be a major. Parents can take apply for a PAN card for the child and gift all taxable investments meant for the child, to her. This will help the parents avoid paying tax. To keep a check on the funds, parents can become joint account holders with the child.
Transfer through will
Creating tax file through will is also very effective way to spread income. Transferring through will does not attract clubbing provisions and one can comfortably bequeath to daughter-in-law, minor children, etc. One may also bequeath to existing HUF or form a new HUF and also form a trust for some beneficiary.
How can Khanna minimise taxes, yet get safe returns? For many people tax planning is related to only making investments under Section 80C. But there are different provisions in the Income Tax Act which, if used judiciously, may help in considerable tax saving. Some of those provisions may apply in this case.
Spreading of income and creating different tax files using gift and settlement provisions is an effective way of tax planning. It is always wise to have tax files of all family members. This may not reduce the tax outgo from the salary or business income, but it will surely help in reducing the taxes to be paid on income generated from investments. Having different tax files leads to usage of basic exemption limits and also in taking benefit of the available tax deduction benefits. These are legal provisions and will not get you in trouble with tax authorities. But be prepared for some amount of additional paperwork.
Gifts received at wedding
For instance, in the example mentioned above, the wedding gifts can be accounted for in the name of Sonali, who is a home maker. As per the gift tax provisions, any gifts received by bride or groom, excluding the gifts received by son-in-law from parents- in-law, is tax free in the hands of receiver. A new tax file in the name of the bride can be created and gift money can be invested in her name to reduce the family's tax burden.
Receiving wedding gifts in the name of bride/daughter-in-law is legal. In this case, when Sonali files taxes, she can take benefit of the basic exemption limit of Rs 2.5 lakh. If her annual income exceeds this limit, she can invest up to Rs 1.5 lakh in specified instruments and claim tax exemption under Section 80 C. Some of these instruments are Public Provident Fund, tax-saver bank FDs, Equity Linked Savings Schemes, National Savings Certificates, life insurance policies. This means that, Rohit and Sonali can enjoy up to Rs 4 lakh tax-free income, in Sonali's name. Even if the income generated exceeds Rs 4 lakh, Sonali will still be in the lowest tax-bracket, and her tax liability will be much lower than that of Rohit.
One thing to note here is that this kind of transaction can help only at the time of the wedding. After that, once the relationship is established as daughter-in-law, if parents-in-law or even the husband want to gift or invest any amount in her name, then though the amount received by the wife will be tax free, the returns generated out of that amount will be clubbed in the income of the transferor.
But any gift received from her parents or her siblings will be tax free and investments out of that will be taxed in her name, not the transferor's name.
Clubbing provisions
Gift tax provisions should always be seen in conjunction with the clubbing provisions as laid down under Section 60-64 of I-T Act. These sections deal with the cases where taxpayer uses the gifting process as a means of transferring the tax incidence on other person, but actually the income is being enjoyed by the transferor.
As per gift tax provisions, gifts received from blood relatives (spouse, parents, your and spouses' siblings, maternal or paternal aunts and uncles and their spouses, brothers-in-law and sisters-in-law), or on the occasion of wedding and also as inheritance through Will, will be tax-free in the hands of receiver. But clubbing provisions have laid down few instances where the income generated from the gift or transferred income will be clubbed back in the income of transferor. Some of the instances are investing in the name of non-earning spouse or daughter-in-law, or in the name of minor children.
Income in the name of minor child
Income generated in the name of minor child is exempt only up to Rs 1,500 per month. Any amount over and above this will be clubbed in the income of the parent whose income is higher. But if someone wants to build a tax file in the name of the minor child and invest in taxable instruments, then he can avoid clubbing by creating a 100 per cent specific beneficiary trust, with a special mention of deferment of the benefit during the minority of the minor child, that means till the child turns 18 years. This will ensure that any income generated by this trust will be taxable at the trust level and the benefit of basic exemption limit and tax deductions can be availed of. Taxation is same as for individuals. so, the family can avail of an additional Rs 2.5 lakh exemption in the name of the trust.
Income received by HUF
Tax-payers who are Hindus can also take help of the Hindu Undivided Family (HUF), which is recognised as a separate entity for taxation purposes. One may also form an HUF and gradually build a tax file in that name, by receiving gifts from relatives. Provisions of gift tax do apply here, but clubbing only gets attracted where gifts are given by HUF members.
Investments in the name of child
While saving for child's future, generally one invests in equity related tax-free instruments in the initial years and later on moves to safer taxable instruments. By the time child enters college, she will be a major. Parents can take apply for a PAN card for the child and gift all taxable investments meant for the child, to her. This will help the parents avoid paying tax. To keep a check on the funds, parents can become joint account holders with the child.
Transfer through will
Creating tax file through will is also very effective way to spread income. Transferring through will does not attract clubbing provisions and one can comfortably bequeath to daughter-in-law, minor children, etc. One may also bequeath to existing HUF or form a new HUF and also form a trust for some beneficiary.
The author is planner and founder, Good Moneying Financial Solutions