Saving Taxes has always been a priority area for any tax payer. Even from a Financial Planning perspective, taxes are treated as a hole in Investors pocket which increase the outflow thus reducing the surplus. But good news is that a lot of tax saving is possible through proper tax planning, within the provisions of tax laws. Please remember that tax planning does not mean Tax evasion where the tax payer conceals some part of his income to avoid tax payments, which is illegal.
This article highlights a specific tax planning technique which if used judiciously can help in saving lot of tax.
Spread your income among your Family members.
Create as many tax files as you can in your family , so that each one of them become independent tax payers. This does not reduce the tax outgo of your salary/business income but will help in reducing the taxes generated out of the income earned on investment of the surpluses. I know that it is not possible to arbitrarily divide one’s income to different family members and then pay lower tax on that, but this goal can be achieved with the help of Gifts and settlement provisions.
Advantages of creating different tax files :
- You may distribute the further income generated out of the investments made which otherwise would have been added in your total income and taxed accordingly. For e.g doing 10 lakh of FD in your name @ 8% rate of interest will increase your taxable income with Rs 80,000/- and tax with Rs 24000/- (assuming tax rate 30%). With spreading income you could be able to save this tax.
- You may take Housing loan from other family members and take benefit of interest payment u/s 24. This benefit is not possible if total savings are in your name.
- If you are in business, you may take loan from other family members and take benefit of interest payment by showing it as business expense.
Understand the Gift tax provisions.
Gift tax is governed by income tax act u/s 56(2). As per this act any gift above the value Rs 50000 in the form of cash , valuable artifacts, shares, valuable drawings, jewellery, paintings or sculptures or even property where stamp duty would be over Rs 50,000 would be taxable in the hands of recipient. This is applicable only in the case of Individuals or HUFs. Thus any gift received by Trust or Association of person does not get covered under this act and thus are non taxable.
The gifts received from the following people or in following circumstances will be tax free in the hands of receiver.
1. Gifts by relatives which includes
- Siblings & their spouses(self and spouse )
- Parents and their Siblings ( self and spouse)
- Any Lineal ascendant or descendant ( Self & Spouse)
2. On the occasion of Marriage (this excludes the gifts received by Son in law from parents in Law)
3. As inheritance through WILL.
Now it might be looking very easy to create different tax files by gifting amounts to family members, but the gift tax provisions has to be read in conjunction with the clubbing provisions which are detailed u/s 60-64 of income tax act 1961. These sections deal with the cases where tax payers make an attempt to reduce the tax liability by transferring / gifting their assets in favour of family members or by arranging their sources of income in such a manner that tax incidence falls on others, but in actual the benefit of income enjoyed by them. Some of the instances it covers are,
- Investing in the name of non earning spouse/daughter in law.
- Investing in the name of minor children
- Giving salary to the spouse out of business where the spouse actually doesn’t have any technical knowledge or experience.
Mainly these clubbing provisions are applicable on the immediate family members. This says that any income generated by Spouse, daughter in law or minor child (more than Rs 1500) out of gifted amount will be clubbed with the income of transferor and taxed as per the income tax slab he/she falls in.
How to create different Tax files through Gifting and avoid clubbing
- To avoid clubbing you have to be sure that you should not gift or invest anything directly to your spouse, daughter in law or Minor child.
- You may gift to your parents if they fall in lower tax slab than yours.
- You may gift any amount to your major kids and create their tax files. If you follow a financial planning approach which says that come out of risky instruments say equity at least 3 years before the goal. One of your goal is Children education and marriage. So once your kids become major shift the portion of your savings meant for them in their name to reduce your tax outgo in the last 3 years, also do future savings for them through their file only.
- If you don’t have Major kids then you may create a Specific Beneficiary non-revocable trust in favour of your minor child and save for his future through that trust. Money transferred to that trust will not be treated as gift but the income earned by that trust will be taxable as per the individual tax slab.
- You can also create a good tax file in the name of your Daughter-in-law by compiling all cash gifts received at the time of marriage.
- You may create a Tax file by starting off with your HUF (Hindu Undivided Family)
- Create different tax files through WILL and do tax planning for your successors.
Tax Evasion is illegal, but tax planning within the scope of different tax laws is completely legal So one should make the best use of it and should not indulge in evasion activity.