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The Income-tax Act, 1961 contains specific provisions for "clubbing" income, which refers to the inclusion of another person’s income in the taxpayer's total income under certain circumstances. One important aspect is the clubbing of a spouse’s income. Section 64(1) of the Act mandates that the income of the spouse can be included in the total income of an individual in certain situations. This provision prevents tax avoidance by transferring assets or income to the spouse and ensures that the correct tax liability is accounted for.

This article delves into the provisions related to the clubbing of a spouse's income, focusing on salary, income from transferred assets, and specific transfers made for the benefit of the spouse.

1. Clubbing of Spouse’s Income from Salary or Remuneration (Section 64(1)(ii))

As per Section 64(1)(ii), the income earned by the spouse of an individual by way of salary, commission, fees, or any other form of remuneration from a business or concern where the other spouse has a "substantial interest" is to be included in the total income of the individual.

Substantial Interest:

An individual is said to have a "substantial interest" in a concern if:

• In the case of a company, Individual or their relatives own shares carrying at least 20% of the voting power at any time during the previous year.
• In the case of any other person, individual or their relatives are entitled to at least 20% of the profits at any time during the previous year.

As the word “relative” has not been defined in context to the above provisions. The definition has to be adopted from section 2(41), according to which “ Relative” means the husband, wife, brother or sister or lineal ascendant or descendant of the individual.

Exception:

If the spouse possesses technical or professional qualifications and the income is solely attributable to such knowledge, skill, or experience, then the income will not be clubbed.

Example:

• Let’s consider an individual, Mr. A, who owns 25% of the voting power through shares in a company. His spouse, Mrs. A, is employed by the same company and receives a salary of ₹10,00,000 during the financial year. Since Mr. A has a substantial interest in the company, Mrs. A's salary will be clubbed with Mr. A's income unless she has professional qualifications, and the salary is directly attributable to her skills.
• If Mrs. A has a degree in accounting and is working as a financial analyst in the company, the income will not be clubbed, provided the Assessing Officer is satisfied that her salary is based solely on her professional expertise.

Determining Whose Income to Club (Explanation 1 to Section 64(1))

When income is clubbed under Section 64(1), it is essential to determine whose income it should be included in—either the husband or the wife. Explanation 1 to Section 64(1)(ii) provides a guideline:

• The income from the spouse will be clubbed with the income of the spouse whose total income (excluding the income referred to in Section 64(1)) is greater.
• Once the income is clubbed with one spouse’s income, it will continue to be clubbed in future years unless the Assessing Officer determines otherwise.

Example:

If Mr. D earns ₹15,00,000 per year and Mrs. D earns ₹10,00,000 from her business (where Mr. D holds a substantial interest), then Mrs. D’s income will be clubbed with Mr. D’s income because his income (₹15,00,000) is greater than hers.

2. Clubbing of Income from Assets Transferred to Spouse (Section 64(1)(iv))

As per Section 64(1)(iv), any income arising from assets transferred, directly or indirectly, by an individual to the spouse without adequate consideration will be clubbed in the individual’s income except where the asset has been transferred in connection with an agreement to live apart.

This provision is designed to prevent taxpayers from transferring income-generating assets (such as property or investments) to their spouse as a means of reducing their tax liability.

Key Points:

• The transfer of assets is without adequate consideration.
• The transfer of assets should not be related to any agreement to live apart (e.g., in cases of separation or divorce).

Example:

Mr. B transfers ₹10,00,000 to his spouse, Mrs. B, without any consideration and Mrs.B invests the said amount in a fixed deposit. The interest earned on this fixed deposit during the year is ₹80,000. Since the amount transferred by Mr. B to Mrs. B is not in connection with an agreement for separation, the interest income of ₹80,000 will be clubbed with Mr. B’s income, and he will be liable to pay tax on it.

Asset are invested in the business by the spouse:

Explanation 3 to Section 64(1)(iv) of the Income-tax Act clarifies that if a spouse utilizes a transferred asset to run or start a business or as a capital contribution in a firm in the capacity of a partner, only the proportionate income, attributable to the transferred asset as it stood on the first day of the financial year, is clubbed with the transferor's income.

This means that for the purpose of calculating clubbing, the value of the transferred asset on the first day of the financial year is used to determine the portion of business income that is to be clubbed with the transferor's income.

Example 1:

• Mr. F transfers ₹10,00,000 to his spouse Mrs. F on 1st April 2023 (the first day of the financial year 2023-24). Mrs. F uses this amount to start a business with a total capital of ₹40,00,000 (including her own contribution of ₹30,00,000).
• The business generates an income of ₹8,00,000 during the financial year 2023-24.

Here’s how the clubbing works:

• The total capital employed in the business as of 1st April 2023 is ₹40,00,000.
• The proportion of capital from the transferred asset as of 1st April 2023 is: ₹10,00,000 (transferred asset) / ₹40,00,000 (total capital) = 25%.
• Therefore, 25% of the business income will be clubbed with Mr. F’s income.

Clubbing Calculation:

• Total income from business = ₹8,00,000
• Clubbed portion (25%) = ₹8,00,000 × 25% = ₹2,00,000
• Thus, ₹2,00,000 will be included in Mr. F’s taxable income for the financial year 2023-24

Example 2:

• Mr. A transfers ₹10,00,000 to his spouse Mrs. A on 1st April 2023 (the first day of the financial year 2023-24).
• Mrs. A invests this amount as capital in a partnership firm where she is a partner.
• The total capital contribution of Mrs A in the firm on 1st April 2023 is ₹50,00,000, which includes her investment of ₹10,00,000 from the funds received from Mr. A.
• The firm generates a total income of ₹30,00,000 during the financial year 2023-24, and Mrs. A’s share of the firm's profits for the year is ₹6,00,000.

Here’s how the clubbing works:

• The total capital contribution in the partnership firm as on 1st April 2023 is ₹50,00,000.
• Out of this, ₹10,00,000 (20% of the total capital) is contributed by Mrs. A from the funds transferred by Mr. A.
• Hence, the proportion of income attributable to the transferred funds is 20%.

Income to be Clubbed:

• Mrs. A’s total share of profits from the firm is ₹6,00,000.
• The portion attributable to the transferred capital is 20% of her profits.
• Clubbed portion = ₹6,00,000 × 20% = ₹1,20,000

3. Clubbing of Income from Transferred Assets Benefitting the Spouse through Third Parties (Section 64(1)(vii))

Section 64(1)(vii) extends the clubbing provisions to cover cases where an individual transfers assets indirectly to their spouse through a third party or an association of persons. If the income from such assets is for the immediate or deferred benefit of the spouse, it will be included in the individual’s income.

Example:

Mr. C transfers assets worth ₹5,00,000 to a trust, with the stipulation that the income from these assets will be used to pay an allowance to his wife, Mrs. C. The income generated by the assets and paid to Mrs. C will be clubbed with Mr. C’s income, even though the transfer was indirect and made through a trust.

4. Clubbing in Case of Partition of HUF Property (Section 64(2))

When an individual converts their separate property into Hindu Undivided Family (HUF) property and later the property is subject matter of partition it, the income received by the spouse from the converted property shall be clubbed with the income of the individual.

Conclusion:

In conclusion, Section 64(1) plays a crucial role in preventing manipulation of tax liabilities through the transfer of income or assets to a spouse. Understanding when and how clubbing applies to a spouse's income is essential for proper tax planning. Whether it’s income from salary, transferred assets, or investments, taxpayers need to stay informed and ensure that they factor in these provisions while computing their total income. Effective tax compliance will help avoid the risk of penalties and ensure fairness in tax reporting.

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Disclaimer:

This article is based on my personal understanding of relevant provisions of the Income-tax Act and judicial precedents and should not be construed as legal advice. Taxpayers should seek professional advice for specific matters.