Clubbing provision — when applicable

QUESTION: I advanced an interest free loan of Rs. 5 lakhs to my wife which amount she kept in term deposit account earning interest. The principal amount was repaid to me after a period of 11 months. Is interest income taxable in my hands?

ANSWER: Though each person pays tax on his income, the law provides for clubbing provisions, so as to defeat diversion of income from the person who should be liable for tax. Income of minor children is automatically aggregated with the income of either parent with higher income. Income from assets transferred to spouse or to son's wife without consideration (gift or settlement) will be clubbed with the income of the transferor. Similarly, revocable transfer of income or income from revocable transfer of assets even to others are taxable in the hands of the transferor under Section 60 to 63 of the Act.

If what is given is only by way of loan to spouse, income from loaned amount cannot be clubbed in the hands of the lender, since transfer of such funds by way of a loan, even where no interest is charged, is not a transfer without consideration. Obligation to return the loan itself is consideration. However, assessing officers are not bound to accept transactions at face value. If a loan is given to the wife, who is not in a position to return the same out of her own assets or income, it may be inferred as a benami or a colourable transaction so that it can be disregarded as a transaction solely with a view to avoiding tax and therefore to be ignored following the rationale of the decision in McDowell & Co. Ltd. v CTO (1985) 154 ITR 148 (SC). Where the wife is not an assessee at all, the assessing officer may well attempt to treat the same as income of the reader. It is for assessee to justify that the transaction is a bona fide loan.

Q: I had gifted Rs. 1 lakh out of my VRS receipts to my two sons jointly, the amount being invested in fixed deposits. In whose hands should the interest income be offered? Whether equally as between them or in my hands, or by treating both of them together as AOP?

A: Since it is stated to be a gift to adult sons, the question of taxing the reader does not arise at all. Once he has gifted away, the question of the reader having to decide the respective rights in the joint account of his sons does not again arise. It is the manner in which the sons understand their respective rights over the deposit that will decide liability. It is not necessary to tax them together as an Association of Persons (AOP), since the income is from investment so that income-tax law expects tax payment on the respective incomes of the brothers and does not ordinarily justify combinations of incomes of different persons unless such income or gains are earned by joint efforts. Normal inference is that they have equal right in the joint deposit so that each will offer his proportionate share in his income tax return.

S. Rajaratnam