Mr Sharma, a marketing professional, recently got a bonus of 5 lakhs and invests it in fixed deposits in his wife’s and daughter’s names.
Mrs Sharma is a homemaker and her daughter has recently started working. She earns less than 2.5 lakhs annually and is not liable to pay any taxes. Mr Sharma is in the 30% tax slab. Can the family save on taxes on the interest earned from these deposits?
The interest earned by Mr Sharma’s wife will be clubbed with his income and taxed according to his income slab. The interest earned by the daughter, however, will not be taxed.
CLUBBING OF INCOME
Any transfer of assets to close relatives (parent, spouse, sibling, lineal ascendant/descendant) is not taxed. Many people use this rule to transfer assets to others who are either in a lower tax bracket or do not pay tax at all and save tax on income from these assets.
Any income from investments made or assets purchased in the name of close relatives (spouse, minor child or daughter-in-law) is clubbed with the income of the person making the investment and taxed accordingly. This applies to all types of investments such as mutual funds, fixed deposits, property etc.
So, if a person opens a fixed deposit in his wife or minor child’s name, the interest earned will be clubbed with his income. Also, if a person buys a property in the name of his wife, who has not contributed any money, the rental income will be clubbed with his income.
Is there a solution?
- Invest money in your parents’ names: To save tax, you can gift a certain amount of money to your parents if they are in a lower tax slab than you. This amount will not attract any gift tax. You can invest in your parent’s name with this amount. Since they are in a lower tax slab, the tax to be paid on the profit or interest will be less than what you would have had to pay if you would have invested the same amount in your own name.
- Save tax through MAJOR children: All your adult children are as solid as a rock to help you save income tax. Investment made by major children out of the gift received by you will be taxed as per the tax slab of your children.
- Investing money in the name of your spouse does not help: INITIALLY* Assume you provide money to your spouse who is not working. That money is invested by the spouse and an income is generated from this gift. The income that arises from this investment can be clubbed to your income. However, if your spouse reinvests the income portion and earns further income then that income may not be clubbed with your taxable income.
Say you gift your wife 25 lakhs which is invested and earns a profit of 2 lakhs. This 2 lakhs will be clubbed with your income. The good news is when this 2 lakhs is reinvested and earns further profit, then this profit is not clubbed with your taxable income.
To summarize, you will not be taxed when you:
- Gift to Parents
- Gift to Major Child
You will be taxed when you:
- Gift to spouse
- Gift to minor child
- Gift to son’s wife