While tax planning you should take precaution to avoid clubbing. Section 64 of income tax act 1961, states clearly when salary, commission, fees or any other form of remuneration will be clubbed.
Salary, commission, fees or any other form of remuneration will be clubbed in the hands of the individual only when he/she has substantial interest in the business. It doesn’t matter whether these are paid in cash or kind.
This means if husband is paying salary, commission, fees or any other form of remuneration to wife from a proprietorship concern or Partnership firm or company in which he has substantial interest, then the entire amount so paid will get clubbed in the hands of husband and taxed accordingly as if it’s his income.
In case remuneration is received by the wife of individual from some other person or business in which the husband does not have substantial interest, them clubbing can’t be done.
Similarly if wife has substantial interest instead of husband in above case, then salary, commission, fees or any other form of remuneration to husband from such concern will get clubbed in the hands of wife.
This means any remuneration derived by a spouse from a concern in which the other spouse has substantial interest, shall be clubbed in the hands of the spouse who has substantial interest in that concern.
To club the above income into the hands of wife or husband you should first understand what is substantial interest.
What is substantial interest
As per explanation 2 to section 64(1)(ii), an individual shall be deemed to have substantial interest in the concern, if in case of a company, the individual along with relatives at any time during the previous year own beneficially, shares carrying not less than 20% of the voting power.
In any other case, the Individual will be deemed to have substantial interest if the individual alone or along with relatives is entitled to at least 20% of the profit of such concern at any time during the previous year.
Exceptions to the above clubbing provision
As per section 64 of income tax act, 1961, clubbing of salary or commission should not apply to the person if spouse possess technical or professional qualifications and the income is generated because of that technical or professional qualifications and experience.
This means, if husband has substantial interest in a proprietorship business or professional firm or company or in any other type of organization and salary has been paid to wife based on her technical or professional qualification and experience, then such salary income of wife can not be clubbed into the taxable income of husband.
To avoid clubbing, you should structure salary or commission paid to spouse in such type of cases by taking into account his/her technical or professional qualifications and experience.
What happens when both husband and wife has substantial interest
As per circular number 258 dated 14.06.1979, if both husband and wife has substantial interest in the concern and both of them are getting remuneration from such concern, then remuneration of both shall be clubbed in the hands of that spouse whose total income, before including such remuneration is higher.
For instance, suppose Mr X and Mrs X, getting remuneration of Rs 25,000 per month and Rs 20,000 per month respectively from XY & Co.
Other income of Mr X and Mrs X is Rs 3,40,000 and Rs 4,60,000 respectively.
The shareholding of Mr X and Mrs X in the concern is 22% and 24% respectively. In such case, both Mr X and Mrs X has substantial interest in XY & Co.
In this case, clubbing provision is applicable as both Mr X and Mrs X has substantial interest in XY & Co. As such, remuneration of Mr X and Mrs X will get clubbed into the hand of Mrs X as her other income is higher in comparison to Mr X.
Calculation of gross total income of Mr X and Mrs X:
- In case of Mr X, Rs 3,40,000 will be considered as his gross total income as remuneration from XY & Co is getting clubbed in the hands of Mrs X.
- In case of Mrs X, other income of Rs 4,60,000 is to be added to remuneration of Mr X and Mrs X. This means salary income of Mrs X = [(Rs 25000*12) – Rs 40,000 ]+[(Rs 20,000*12) – Rs 40,000] = Rs 2,60,000+Rs 2,00,000 = Rs 4,60,000. Therefore, gross total income = Other income of Rs 4,60,000+ Salary income of Rs 4,60,000 = Rs 9,20,000. Mrs X has to consider her gross total income as Rs 9,20,000.
However, if Mr X and Mrs X can prove that remuneration from XY & Co has been derived due to the both person’s technical or professional knowledge and experience, then clubbing provision will not be applicable and salary of Mr X will be taxed in his hand in addition to the other income instead of clubbing in the hand of Mrs X.