With festive times here, chances are that you will take this opporunity to make cash gifts to your near and dear ones. Gaurav Taneja and Rakesh Dharawat, senior tax professionals with Ernst & Young, tell you the tax implications.

A notable feature of tax legislation, especially in developed economies, is taxation of gifts. This generally takes the form of taxing the donee on the gifts received, but sometimes the levy can also be on the donor. India too was no exception to this, and not only were gifts taxable under the Gift tax Act 1958, the said legislation also provided for a separate set of compliances for example, filing a gift tax return, etc.

However, this legislation has been amended to provide that no gift tax shall be levied on any gifts made on or after October 1, 1998. The amendment had the effect of abolition of the levy of gift tax and the tax payers heaved a sigh of relief.

Nonetheless, expectedly, even post the above amendment, the tax authorities typically required the donee to substantiate and prove the genuineness of the gift, generally in case of gifts of large amounts, especially where the donor was a non-resident abroad. In case the donee failed to convince the tax authorities, then the gifts received were taxed as ‘income’ in the hands of the donee. What constituted proof and what was the degree of evidence required in such cases was a subject matter of considerable litigation. Based on judicial precedents, the genuineness of the gift, the identity of the donor and his capacity to give the gift could typically be sufficient evidence for proving the gift for tax purposes.   

In the above backdrop, the Finance Act 2004 with effect from September 1, 2004 onwards, amended the Income-tax Act, (Act) to provide that any money received by an individual or Hindu Undivided Family (HUF) without consideration, from any person in excess of the limit specified (currently Rs 50,000 in aggregate) will be taxable as income in the hands of the recipients.  In case, the recipient falls in the highest tax bracket, then such sum of money would be currently taxable at 33.66%.  The object of this amendment was to curb money laundering and tax evasion through the medium of gifts.

Nonetheless, not all gifts are liable to tax based on the above as certain exemptions have been provided. One such exemption is with respect to receipts from certain specified relatives, or gifts received on the occasion of marriage of an individual.  Further, any sum of money received under a will or by way of inheritance or in contemplation of death of payer is also specifically exempt from the above levy.  Additionally, with effect from April 1, 2006, the exemption also covers any monies received from certain charitable or specified institutions.

As regards relatives, surprisingly, amounts received only from the following relatives are exempt:

i)                    Spouse of the individual;

ii)                   Brother or sister of the individual;

iii)                 Brother or sister of the spouse of the individual;

iv)                 Brother or sister of either parents of the individual;

v)                  Any lineal ascendant or descendant of the individual;

vi)                 Any lineal ascendant or descendant of the spouse of the individual; or

vii)               Spouse of the person referred to in clause (ii) to (iv).

The above restrictive definition of ‘relatives’ and the way the exemption is worded throws up interesting issues.

For example, if X was to receive any gift from his uncle (father’s brother), it would not be taxable in his hands since a gift from brother or sister of either parent is included in the exceptions above.

However, if X wants to give a gift to his uncle, then in such case X would not qualify as a ‘relative’ of the uncle since a child of brother or sister is not covered in the above-referred exceptions. Hence, the amount of gift received by his uncle would be taxable in his hands as his income. (3 reasons why you must make tax saving investments today )

The above example would become more complex if the uncle is a Non-Resident Indian (HUF). In such a case, if X were to give a gift to his uncle, then the uncle will be taxable in India only if it is received in India.

Similarly, if Y wants to give a gift to his aunt (mother’s sister), then, the aunt will be subject to tax as a gift from children of brother or sister is not covered in the above exception. However, if Y receives a gift from his aunt, then he will not be subject to tax since a gift from brother or sister of either parent is included in the exceptions above. What follows is, the aunt is considered as a ‘relative’ of Y where he receives the gift from her, but Y is not treated as a ‘relative’ of his aunt when he wants to give a gift to her.

Pertinently, the amendment applies only to gifts received by an individual and an HUF and hence, a company or a partnership firm or any other entity would be outside the ambit of the levy.

Another notable issue is that this new levy applies only to any sum of money received by an individual/ HUF (Hindu Undivided Family) i.e. cash gifts and would not apply to gifts received in kind.

The import of the above is that gifts received by a person would be taxable as his income even though these are genuine, bonafide and he can prove the identity and capacity of the donor, unless these are covered in the above exemption or are below Rs 50,000 in aggregate. Thus, a gift by a wealthy person to his close friend or the friend’s children would be taxable in the hands of the recipient.

To sum up, the effect of the amendment is that all gifts would be taxable as ‘income’, unless these are specifically exempt. The stated objective - to curb the malpractice of money laundering and tax evasion through the medium of gifts is laudable, however, the sweep of the enactment is quite broad since the rigor of the provision applies even to cases where there is in fact no money laundering or tax evasion.

The authors, Gaurav Taneja and Rakesh Dharawat, are senior tax professionals with Ernst & Young.