RELATIVES UNDER THE INCOME TAX ACT - A RELATIVE CONCEPT

1.0 Human being is called a social animal. The edifice of the society is built on the formal and informal relationship between human beings inter se. Society consists of near and dear one i.e. with whom an individual interacts at various times, occasions and for various reasons viz. financial, religious, business etc.. A human being also deals with unknown in day-to-day life for limited purposes, but largely for commercial reasons, i.e. for buying or selling commodities or services. Such transactions are at arm’s length prices, not involving any dimension of relationship. Interaction with near and dear ones have always encompassed all the types of above said transactions. Mutual confidence in each other has been preferred as it provides comfort while dealing with money.

1.1 Law is supposed to be blind as it is expected to be applicable to each and every human being. Taxing statutes are also equally supposed to be neutral to relationship between the two taxpayers. Transactions attracting tax are expected to be entered into at arm’s length prices. Although business / financial dealings with relatives are expected to be at par or at arm’s length level, reality is not so. Human beings not perfectly rational, element of relationship do creep into financial / business transactions. Taking care of this aspect, taxing statute of each country make suitable provisions in their direct and indirect taxes. For example, in the case of direct taxes viz. income tax, suitable provisions are made to take care of loss in revenue by transferring assets to one’s relatives.

1.2 Each society / country is unique as it posses its distinct identity of culture and traditions. This is the outcome of inter se relationship between its members. Since the taxing statutes are drafted for the taxpayers of a society, it cannot be oblivious of such cultural values and relationship arising out thereof. For example, since centuries, Indian society is having extended form of family. Till few years back, in the Indian traditional social system, relationship used to relate back to seven generations. Even today, the relationship is traced to the three / four generation levels. Not only that, it is also extended to one’s spouses lineal ascendant / descendant as well. This relationship is not restricted to religious or social functions only. It also extends to business / financial transactions as well. In fact, interaction at such functions gives an opportunity for entering into financial relationship. It is for these reasons that one comes across distinctly visible provisions in the arena of direct taxes. Indian Income Tax Act, 1962 is also one piece of such legislation. It makes extensive provisions for disallowance of expenses for transactions between relatives, transfer of assets amongst relatives etc.

2.0 A unique form of reflection of such social system is recognition of Hindu Undivided Family (HUF) under the Income Tax Act as a separate taxable entity. The concept of HUF relates back to century old system of undivided family as described extensively in Manusmruti. India is the only country in the world where, in the case of a male, apart from assessing him on his income, a separate entity is also being presumed belonging to him. Another such case of reflection of social custom in the taxing statute is provisions of S. 56(2)(v) i.e. regarding transfer of assets amongst relatives. One will be surprised to read the length and width of relationship to which exemptions granted under S. 56(2)(v) are extended. For a non-Indian, this may appear to be stretching the matter too far. However, those who are familiar with Indian traditions, offering gift to one’s relatives on the occasions of birth, marriage and various other occasions are very common.

2.1 Law makers have been aware of attempts made by the taxpayers to organize affairs through relatives to keep the tax impact at lower level. Attempts to curb role of relatives in tax saving can be traced back to insertion of S. 64(1) and 64(2) i.e. regarding clubbing of income derived by spouse, daughter-in-law, grand son etc. out of assets gifted. In the same manner, transferring business income to wife / minor children was plugged by inserting provisions like S. 64(1)(iv) and (vi). During the period up to October, 1998 tax was also levied in the form of gift tax for assets transferred without consideration. Once again, transfer of assets through gift came to limelight when the base for taxation was shifted from the donor, as in the case of Gift tax, to the donee.

3.0 Income Tax Act contains various sections, which invoke relationship between two individuals and try to see the real motive behind the transactions. These sections are as follow:

Application of income / assets of charitable trust for the benefit of relatives of the trustee, founder, manager etc.