Understanding the Tax on Profits from Assets Gifted to Your Spouse: A Deep Dive into the ITAT's Landmark Ruling

Gifting assets like property, stocks, or gold to a spouse is a common practice in India. People often do this out of love or for financial planning. While gifting itself is tax-free between spouses, a significant and confusing question arises later: What happens when the spouse who received the gift decides to sell it? Who pays the tax on the profit?

In a landmark decision that clarifies this issue, the Income Tax Appellate Tribunal (ITAT) has established important legal points. Here's a detailed breakdown of the ruling and what it means for you.

The Basics: Gifts are Free, but Profits are Taxed

First, let's understand the fundamental principles of the Income Tax Act, 1961:

• Tax-Free Gifts: Any gift of money or assets between spouses is completely exempt from income tax. The spouse receiving the gift does not have to pay any tax on its value when receiving it.
• Capital Gains on Sale: However, if the recipient spouse later sells this asset, the transaction is no longer a gift. Any profit or "gain" from this sale is considered capital gains and is subject to tax.

The real question is not whether the tax is payable but who pays it. This is where the "clubbing of income" provisions come into play.

The Crucial Twist: Understanding Section 64(1)(iv) - The Clubbing Provision

To prevent individuals from avoiding taxes by transferring assets to a spouse in a lower tax bracket, the Income Tax Act includes a strong anti-avoidance measure known as the "clubbing of income" under Section 64.

Specifically, Section 64(1)(iv) states that if someone transfers an asset to their spouse without "adequate consideration" (which a gift is), any income from that asset must be included or "clubbed" with the income of the person who made the transfer.

The Landmark ITAT Ruling: Capital Gains Must Be Clubbed

The issue recently came before the ITAT's Bangalore bench in a significant case. Here's what happened:

• The Case: A husband gifted a property to his wife. The wife later sold the property and earned a capital gain.
• The Dispute: The question was whether the capital gains should be taxed in the hands of the wife (who sold it) or the husband (who gifted it).
• The Verdict: The ITAT issued a clear ruling: the capital gains from the sale of the gifted property must be taxed in the hands of the husband (the transferor).

The Tribunal's Reasoning: The bench explained that Section 64(1)(iv) is mandatory, not optional. Since the property was transferred without adequate consideration, any income from its sale, including capital gains, must legally be clubbed with the income of the gifting spouse. The law does not give "any option either with the assessee or with the Revenue" to tax the income in the recipient's hands.

This ruling reinforces that capital gains are treated as "income from the asset" and fall under the clubbing provisions.

Nuance: What About Tax Exemptions?

Another interesting point came up in a separate ruling by the ITAT's Mumbai bench. In that case, a wife sold flats gifted to her by her husband and then reinvested the proceeds into a new residential property, claiming a tax exemption under Section 54.

The tax department argued that since the husband was the "deemed owner" due to clubbing provisions, the wife couldn't claim the exemption. The ITAT pointed out the inconsistency in this argument. It ruled that if the capital gains are assessed in the wife's hands, she must be entitled to claim the related exemptions.

The key takeaway is that the person who is ultimately taxed on the income can claim all eligible deductions and exemptions tied to that income.

What This Means for Taxpayers: Key Takeaways

1. The Gifter Pays the Tax: The main rule is now clearly established. If you gift an asset to your spouse and they later sell it at a profit, the capital gains tax liability will be yours.
2. Clubbing is Mandatory: You cannot choose to have the gains taxed in your spouse's hands, even if they are in a lower tax bracket. The clubbing provision is not optional.
3. Calculation of Gains: Keep in mind two important rules for calculating capital gains on gifted assets:
   • Cost of Acquisition: The cost will be what the original owner (the gifting spouse) paid for it.
   • Holding Period: The ownership period is calculated from the date the original owner acquired the asset, not from the date of the gift. This determines whether the gain is short-term or long-term.
4. Documentation is Crucial: While the tax liability is clear, it is important to document the transfer legally through a registered gift deed. This proves the transaction was a gift and not a sale.

A Practical Example

Let's put this into perspective:

• 2015: Mr. Sharma buys shares of a company for ₹10 lakhs.
• 2022: He gifts these shares to his wife, Mrs. Sharma. At this time, no tax is due.
• 2025: Mrs. Sharma sells the shares for ₹25 lakhs.

The Tax Outcome:

• Sale Consideration: ₹25 lakhs
• Cost of Acquisition: ₹10 lakhs (Mr. Sharma's original cost)
• Long-Term Capital Gain: ₹15 lakhs (ignoring indexation for simplicity)

Based on the ITAT ruling, this ₹15 lakh capital gain will be added to Mr. Sharma's income for the year and taxed according to his applicable tax rate, not Mrs. Sharma's.

Disclaimer

This article is for informational purposes only and does not constitute financial advice. Tax laws are complex and subject to change. Please consult a qualified tax advisor for guidance on your specific financial situation.

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