Legal strategies for avoiding clubbing of income

Clubbing provisions are anti-avoidance rules under the Income Tax Act, 1961, mainly covered under sections 60 to 64. These provisions aim to prevent taxpayers from reducing their tax liability by transferring income to others, especially spouses, minor children, or relatives.

However, with proper legal structuring, taxpayers can avoid clubbing of income legitimately. Here’s a detailed guide on legal strategies to avoid clubbing:

1.  Avoid Gifting Income:

Producing Assets to Spouse/Minor Children Gifts to a spouse or minor child can result in clubbing. Instead, consider investing in the name of a major child (age 18+) or parents. Do not gift assets to son’s wife.

2.  Invest in Tax-free instruments for Gifted Money:

If you still gift money to spouse, invest in tax-free instruments. (e.g. PPF, tax-free bonds). Clubbing applies only to income, not capital gains or exempt income.

3.  Create a trust:

Form a discretionary trust with multiple beneficiaries (spouse, children, parents). Income is taxed in the trust’s hands under MMR

4.  Use Loans instead of Gifts:

Instead of gifting assets, give a loan with a reasonable interest rate and clear documentation. Income from such loans won’t be clubbed.

5.  Wills and Inheritance

Clubbing provisions do not apply to transfers through will or inheritance. Use wills to plan wealth transfer to spouse, children, or others to avoid future clubbing.

6.  Complete transfer of assets:

Make the transfer irrevocable – no clause for taking back the asset or controlling the income. Avoid conditions allowing reversion of the asset back to the transferor.

7.  Family settlement:

Enter into a family settlement deed redistributing income-producing assets among members.

If it is bona fide and for resolving family disputes (not tax avoidance), courts have upheld no clubbing.