WHAT IS GIFT TAX? WHAT ARE INCOME CLUBBING PROVISIONS AS TO GIFTS IN INDIA AND THEIR TAX IMPLICATIONS?

WHAT IS GIFT TAX?  WHAT ARE INCOME CLUBBING PROVISIONS AS TO GIFTS IN INDIA AND THEIR TAX IMPLICATIONS?

By K P C Rao., LLB.,  FCMA., FCS

Practicing Company Secretary

kpcrao.india@gmail.com

1.      BACKGROUND

Gift tax in India is regulated by the Gift Tax Act, 1956 which was constituted on April 1, 1958. It came into effect in all parts of the country except Jammu and Kashmir. As per the Gift Act 1958, all gifts in excess of ` 25,000, in the form of cash, draft, cheque or others, received from one who doesn't have blood relations with the recipient, were  taxable.

However, with effect from October 1, 1998, gift tax got demolished and all the gifts made on or after the date were free from tax. But the Finance Act 2004 has revived it partially, but it is in the form of donee-based income tax instead of gift. The Income Tax Office is empowered to collect the assessed tax, directly from the donee but the amount will be what the donor would have paid on the clubbed income. However, the Income Tax Office is required to serve on the donee a notice of demand.

2.      WHAT IS A GIFT?

As per Section 2 (xii) of the Gift-Tax Act, 1958, ‘Gift’ means the transfer by one person to another of any existing movable or immovable property made voluntarily and without consideration in money or money’s worth, and includes the transfer or conversion of any property referred to in section 4 of Gift Tax Act, 1956, deemed to be a gift under that section. According to Explanation given under this section a transfer of any building or part thereof referred to in clause (iii), clause (iiia) or clause (iiib) of section 27 of the Income-tax Act by the person who is deemed under the said clause to be the owner thereof made voluntarily and without consideration in money or money’s worth, shall be deemed to be a gift made by such person.

(a)  What about the gifts received between 01.04.2006 to 30.09.2009?

Where any sum of money, the aggregate value of which exceeds ` 50,000 is received without consideration by individual/HUF, the whole of aggregate value is taxable as income from other sources.

Provided that this clause shall not apply to any sum of money received;

(a)  from any relative; or

(b)  on the occasion of marriage of the individual; or

(c)  under a will or by way of inheritance; or

(d)  in contemplation of death of the payer.

(b)  What about the gifts received on or after 01.10.2009?

With effect from 1.10.2009, new clause [Sec. 56(2)(vii)] is introduced for charging of Gifts received by individual/HUF. Earlier, only gifts received in the sum of money was chargeable under Income Tax Act. However w.e.f. 01.10.2009 gift received in kind is also chargeable subject to certain conditions. The new provisions are described as under:

I.       If any sum of money received without consideration, the aggregate of which exceeds ` 50,000, the whole of such sum will be chargeable.

II.    If any immovable property received –

(a)  without consideration, the stamp duty value of which exceeds ` 50,000, the stamp duty value of such property will be chargeable.

(b)  For a consideration, which is less than stamp duty value of property by an amount exceeding ` 50,000, the stamp duty value of such property as exceeds such consideration will be chargeable.

III. If any property other than immovable property received –

(a)  without consideration, the aggregate fair market value (FMV) of which exceeds ` 50,000, the whole of aggregate FMV of such property will be chargeable.

(b)  For a consideration, which is less than the aggregate FMV by an amount exceeding ` 50,000, the aggregate FMV as exceeds such consideration will be chargeable.

However any such gifts received from relatives shall not be treated as income.

(c)  What is the Meaning of a Relative?

Explanation to Sec. 56(2) (vi) provides that the expression "relative" means:

(1)        Spouse of the individual;

(2)        Brother or sister of the individual;

(3)        Brother or sister of the spouse of the individual;

(4)        Brother or sister of either of the parents of the individual;

(5)        Any lineal ascendant or descendant of an individual;

(6)        Any lineal ascendant/descendant of spouse of the individual

Meaning of the expression ‘Relative’ in terms of the explanation given under Section 56(2) (vi) of the I.T Act can be better explained with the following diagram:

Surprisingly, and for no particular reason, this definition differs from the definition as contained in Securities Contracts (Regulation) Act, 1956 and also in the Companies Act, 1956. Take the instance of Miss X whose mother's brother is Mr. Y. Yes, Y is a relative of X (Mother's brother) but X is not a relative of Y (Sister's daughter). One may presume if X is a relative of Y, the Y is also a relative of X. Surprisingly it is not under Sec. 56(2) (vi)!

Significantly, the clubbing provisions in the Income Tax Act 1961 and Wealth Tax Act, 1957 are not deleted. Therefore, income and wealth from assets transferred directly or indirectly without adequate consideration to minor children, the spouse (otherwise than in connection with an agreement to live apart) or daughter-in-law will continue to be deemed income and wealth of the transferor. Same is the case when assets are held by a person or an Association of Persons for benefit of assesses, the spouse, daughter-in-law and minor children. Therefore, now the gift received during the previous year shall be included in the income if the aggregate of the gifts received exceeds ` 50,000.

(d)  Whether all the Gifts from Relatives are Tax-Exempt?

Any gift received from relatives of any amount during financial year is completely exempt from tax.  Hence, Gift of more than ` 50,000/- can be received from below mentioned relatives without any taxes.

(1)  Exemption for Marriage Gifts

Any gift received from any person on occasion of marriage of the gift's recipient will not be liable to income tax at all. Also there is no monetary limit attached to this exemption, which is provided by Section 56(2) (vi).

(2)  Tax-Exempt Gifts from other Persons

Besides gifts received from relatives or on occasion of marriage, following are the other gifts which are completely tax-exempt as provided in Section 56(2) (vi) of the I.T. Act:

1)     Gift received from a Will or by way of inheritance;

2)     Gift received in contemplation of death of the donor;

3)     Gift from a local authority;

4)     Gift received from any fund, foundation, university or other educational institution or hospital or any trust or any institution referred to in Section 10(23C); and

5)     Gift received from any trust/institution, which is registered as public charitable trust or institution u/s 12AA.

(3)  Gifts in Kind are Tax-Exempt

Provisions relating to the taxation of gifts from non-relatives & non-specified persons in excess of ` 50,000 will be liable to income tax only when the gift is sum of money, by way of cash, cheque or a bank draft. Gifts in kind like a gift of shares, gift of land, gift of house, gift of units or even mutual funds, jewellery, etc. shall not be liable to any income tax at all.

3.      CLUBBING PROVISIONS

(a)  Under the Income-tax Act, 1961

Under the Income-tax Act, 1961, an assessee is generally taxed in respect of his own income. However, there are certain cases where as assessee has to pay tax in respect of income of another person. The provisions for the same are contained in sections 60 to 65 of the Act. These provisions have been enacted to counteract the tendency on the part of the tax-payers to dispose of their property or transfer their income in such a way that their tax liability can be avoided or reduced.

In the case of individuals, income-tax is levied on a slab system on the total income. The tax system is progressive i.e. as the income increases, the applicable rate of tax increases. Some taxpayers in the higher income bracket have a tendency to divert some portion of their income to their spouse, minor child etc. to minimize their tax burden. In order to prevent such tax avoidance, clubbing provisions have been incorporated in the Act, under which income arising to certain persons (like spouse, minor child etc.) have to be included in the income of the person who has diverted his income for the purpose of computing tax liability.

Sections 60 to 65 of the Act deal the following situations:

a)     Transfer of income without transfer of asset [Section 60]

b)     Income arising from revocable transfer of assets [Section 61]

c)     Exceptions where clubbing provisions are not attracted even in case of revocable transfer [Section 62]

d)     Clubbing of income arising to spouse [Section 64(1)(ii)]

e)     Transfer of assets for the benefit of spouse [Section 64(1)(vii)]

f)      Income arising to son’s wife from the assets transferred without adequate consideration by the father-in-law or mother-in-law [Section 64(1)(vi)]

g)     Transfer of assets for the benefit of son’s wife [Section 64(1)(viii)]

h)     Clubbing of minor’s income [Section 64(1A)]

i)       Cross Transfers

j)       Conversion of self-acquired property into the property of a Hindu Undivided Family [Section 64(2)]

The main distinction between the two sections is that section 61 applies only to a revocable transfer made by any person while section 64 applies to revocable as well as irrevocable transfers made only by individuals.

It is significant to note that as per the Explanation 2 to section 64, ‘income’ would include ‘loss’. Accordingly, where the specified income to be included in the total income of the individual is a loss, such loss will be taken into account while computing the total income of the individual. This Explanation is also equally applies to clubbing provisions under both sections 64(1) and 64(2).

Sections 61 to 64 provide for clubbing of income of one person in the hands of the other in circumstances specified therein. However, service of notice of demand (in respect of tax on such income) may be made upon the person to whom such asset is transferred (i.e. the transferee). In such a case, the transferee is liable to pay that portion of tax levied on the transferor which is attributable to the income so clubbed.

(b)  Under Wealth Tax Act, 1957

According to Section 4 of the Wealth Tax Act, 1957, the following transfers shall be included in the net-wealth of an assessee:

(1)  Assets transferred to spouse [Section 4(1)(a)(i)]

(2)  Assets held by minor child [Section 4(1)(a)(ii)]

(3)  Assets transferred to a person or association of persons [Section 4(1)(a)(iii)]

(4)  Assets transferred under revocable transfers [Section 4(1)(a)(iv)]

(5)  Assets transferred by an individual to son’s wife or son’s minor child including step child and adopted child [Section 4(1)(a)(v)]

(6)  Assets transferred by an individual for the benefits of son’s wife [Section 4(1)(a)(vi)]

(7)  Interest in the assets of the firm, etc. [Section 4(1)(b)]

(c)  Gift under a Will or in contemplation of Death

Gifts under a will or in contemplation of death do not attract stamp duty. According to section 191 of the Indian Succession Act (ISA), Gifts can be made in contemplation of death by a person who is ill and expects to die shortly delivers to another the possession of any movable property (Not immovable) as a gift in case he dies. Such a gift may be revoked by the donor if he recovers from the illness.

(d)  Gifting Minors & Realty

Even gifts received by minors will be brought within the purview of taxes by means of clubbing of income, in case of both parents having taxable income; it will be clubbed with the parent who is earning the highest.

Real estate deals done for values lower than the rates fixed by state governments / local bodies will also be taxed. Here, the tax will be levied on the difference of amount between state government's rate and purchase price. The tax needs to be paid by the buyer of the property.

4.      HINTS FOR TAX PLANNING

ü  The main advantage of gifts accrues from the fact that in the case of spouse or daughter-in-law, income on income is not clubbed. If the spouse has no other income, no tax is payable unless the interest on interest crosses the minimum threshold of `. 50,000. In other words, instead of investing in your own name, and pay tax thereon, it is better to give a gift, pay tax on the original corpus gifted and keep on building a corpus for your spouse. Yes, it is cumbersome to keep track of what is clubbable and what is not, but may be worth the effort.

ü  Unfortunately, this strategy cannot be used in case of minors since their entire income, including interest on interest, is clubbed in the hands of the parent having higher income than that of the other. There is a small solace in the form of exemption of ` 1,500 per child on income earned by the child. More the number of children better is the advantage. Forget family planning!

ü  Notwithstanding all this, it is necessary to ensure that if you have any minor children, you earn an income of at least ` 1,500 for each of them. Income up to that level is free from income tax.

ü  Are you (or your son) intending to get married in a near future? A good idea is to give a fiancée a handsome gift before the marriage. Even the first stage interest will not be taxed in your hands.

ü  Suppose you do not have enough funds to invest the maximum amount necessary to bring down your taxes in avenues covered by section 88 and also takes advantage of the freedom from the tax. You can contribute up to ` 99,000 every year to a PPF account in the name of the child, major or minor and only `. 1,000 to your own account. It is treated as gift but the associated clubbing provision is rendered toothless, since the interest on PPF is tax-free.

ü  You may gift your wife (or daughter-in-law) shares of companies, which are announced bonuses. The capital gains on bonus escape clubbing whereas the loss on original holding arising out of the bonus is welcome for the clubbing. Even the dividend is charged on tax, if it is taxable, in her hand and not his.

ü  Some persons carefully choose cumulative schemes like the 3-year Cumulative-FDs for a child of over 15 years of age, 6 year NSC-VIII for over 12 years, etc. They are under the mistaken notion that the cumulative interest received after the child becomes major will escape clubbing. Interest on these schemes, though paid at the end of their term, accrues on yearly basis and is brought under the ambit of income tax by section 5 of Income Tax Act.

ü  There are couples that have taken a divorce just to bypass the clubbing provision and are staying happily together.

ü  Husbands may give gifts, out of natural love and affection, to someone else’s wife and vice versa. Utmost care is taken to ensure that husband of the donee does not give a gift to donor’s wife. A different wife is selected every year for the favours. Such cross gifts are not permitted by the Act.  The Supreme Court, in case of CIT v. Keshavji Morarji [1967] 66 ITR 142, observed that if two transactions are inter-connected and are parts of the same transaction in such a way that it can be said that the circuitous method was adopted as a device to evade tax, the implication of clubbing provisions would be attracted.

ü  In a far-reaching judgment, the Delhi High Court in the case of R. Dalmis v CIT (1982) 133ITR149 held that savings made by the wife out of house hold expenses given by her husband would be separate property of the wife. Any income arising there-from cannot be aggregated with the income of the husband.

ü  It has now become possible to keep the title of the money to yourself, earn income through long-term capital gain and yet avoid tax by using section 54EC or 54ED. Another method is to use equity-based schemes of mutual funds, which are tax efficient.

ü  Finally, and this would surprise you most, the best method of avoiding clubbing is not to give a gift at all!

5.      CONCLUSION

The Gift Tax has had a bit of a roller-coaster ride in India, with a brief period when it was abolished and then it getting renewed in a new avatar.  It was found that many individuals used the loopholes in the Gift Tax Act, to launder money.  The key reason for bringing back Gift Tax in its latest avatar is to plug loopholes and make norms more stringent. It is clear that exchanging assets amongst relatives to evade taxes have come under control and this has also ensured that the Income tax authorities can keep tab on the movement of assets (movable / immovable). It is also hoped that the new rule will effectively prevents money laundering in the guise of high value gifts.

The new rule related to gifts says that the receiver has to pay tax for receiving any gift valued at ` 50,000 and more. The term 'any gift' means that not only cash but all gifts of any value. The phrase 'received without consideration' is too much generic in nature and therefore, it is litigations-oriented. Whether sum received by way of interest-free loan will fall into this category or not is a question mark.

Deletion of Gift Tax Act has opened floodgates for litigation. Determining whether a transaction is a genuine gift or not, would be at the discretion of the Income Tax Office. Obviously ‘donor-donee’ relationship, financial ability of the donor, justification for giving the gift, etc., have suddenly become paramount parameters. These are essentially subjective in nature. Abolishing gift tax is an excellent idea but not before the infrastructure handling our premier tax legislation as well as the judiciary system is in its right place. The very fact that the cases handled under The Prevention of Money Laundering Act 2002 (PMLA) supports the view that the effective enforcement machinery is not in place. The PMLA came into force with effect from 1 July 2005. The Directorate of Enforcement has so far (up to 16/05/2012) registered only 1437 cases for investigation under the PMLA. During investigation, 22 persons were arrested and 131 provisional attachment orders issued in respect of properties valued at ` 1,214 crore. The Directorate has filed only 38 Prosecution Complaints in PMLA-designated courts for the offence of money laundering. Therefore, the infrastructure in handling these cases should be strong enough so that it would be difficult for anybody to get away with any tax evasion by adopting gifts and the consequent Inspector.

[Published in Corporate Secretary, Monthly magazine of ICSI, Hyderabad]