In families where wives are home makers and husbands are in the highest income tax bracket, there is often a temptation to transfer assets or invest in the name of the spouse or children, whether for emotional or tax saving purposes. We get a lot of queries regarding this subject: can one invest in the name of the spouse or children to lower the tax burden? This is a tricky subject as tax laws do not allow you to avoid taxes by transferring your assets. Many of us are unaware or only partially aware of the provisions of proxy investments, which may make us easily fall foul of the taxman. Income tax has the powerful tool, called ‘clubbing’, which reverse engineers one’s income from that of the transferee. In this post, we shall look closely into the implications of this provision and its complexities.
Gifting money to wife and minor children
Cash or non-cash gift of any amount given by husband to wife is not considered as income in her hands. However, if invested, the interest generated on the gift will be taxable for the husband. Similarly, the clubbing rule ensures that income generated from direct or indirect transfers to minor children gets added to your income, thus defeating the purpose of saving tax.
Also, today, the income tax department is geared to catch any big-ticket transactions in your returns, since most transactions require PAN details. So you need to be careful about tracking your accountable income and avoid indiscriminately gifting and receiving money to relatives. For example, if you gift money to your mother in law who then returns it to your wife, it can still be traced back to you.
Buying a house in the name of your wife
Many intend to buy a second home in the name of their wife to avoid wealth taxes, even though she may have no money of her own to buy it with. Technically, therefore, you are gifting her the house, and the clubbing provisions will apply. The 2019 budget has done away with taxing the notional rent of vacant or self-occupied second homes, but any actual rent received by your wife from a house property gifted by you will be taxed as your rental income. We now have stringent regulations mandating the declaration of PAN for any purchase or sale exceeding Rs. 1 lakh, and provisions to check for splitting of transactions to avoid reporting PAN. The tax laws also prohibit acceptance or payment of an advance of Rs. 20,000 or more in cash for purchase of immovable property. So, there is no real tax benefit in buying property in the name of wife except, maybe, making your wife and in-laws happy.
Joint home loan tax benefit
If you are thinking of availing a home loan in which you are a co-applicant, whereas the owner of the house is solely your wife, you would not be entitled to get tax concessions even if you have been paying full EMI from your taxable income. The law states that you can only claim income tax exemption as a co applicant in housing loan as long as you are also the owner or co-owner of the property in question. Merely paying EMI and being a co applicant in a housing loan would not make you eligible to avail the tax benefits.
For claiming income tax deduction, the EMI amount is divided into the principal and interest components. The repayment of the principal amount of loan is claimed as a deduction under section 80C of the Income Tax Act up to a maximum amount of Rs 1.50 lakh individually by each co-owner. The interest component of home loans is allowed as deduction under Section 24 B for up to Rs. 2 lakhs in case of a self-occupied house. This limit is only for self-occupied house. For a rented property, since 2017, the interest that can be claimed as a deduction in case of rented property is restricted to the amount of loss from such property, not exceeding Rs. 2 lakhs. Hence, each owner/borrower can claim interest benefit up to a maximum of Rs. 2 lakhs.
Mutual fund investments in the name of wife and minor child
If you invest into shares or mutual funds in the name of your wife, and hold these investments for at least 12 months, they are treated as long-term assets. Capital gains on long-term equity funds are tax-exempt up to Rs. 1 lakh, and any capital gains beyond Rs. 1 lakh from selling long term equity funds will be added to your income. Similarly, gains from debt funds are taxable and shall also be clubbed with your income and taxable as per the applicable income-tax slab rate. The same concept applies for investments in the name of your minor children.
If you do not need the money, you can defer the redemption of funds by investing in the growth option until your minor children turn 18. In this case, the growth option mutual fund units redeemed will be taxable in the hands of your children, who may be in the zero- or low-tax bracket.
Band fixed deposits in the name of wife and child
Unlike debt mutual funds, cumulative fixed deposits cannot defer taxes. Under the mercantile system, you will have to pay taxes on the accrued interest at the end of each financial year, even if you do not get anything in hand until the maturity of the fixed deposit (FD). If you invest in FDs in the name of your wife or minor child, you will have to include the interest in your income, due to the clubbing provisions for your gift.
However, when the interest on bank savings in the name of your minor child is clubbed with your income, Rs. 1,500 interest per child is exempt from tax and is allowed for a maximum of two children. So, if you are in the highest tax bracket of 30%, this provision gives you a saving of Rs. 1000 on Rs. 3000 interest earned per year.
The key to tax savings with investment in the name of your family members is that the money should be transferred to a family member in the lower tax bracket carefully, without resorting to unlawful methods, to prevent being viewed as tax avoidance.