Income Assignment under Tax Law
Definition of Income Assignment:
"Income Assignment" refers to a situation where an individual or entity transfers the right to receive income to another person without transferring the source (or the asset that generates that income). Under tax law, such assignments are often scrutinized because the income remains taxable in the hands of the person who owns the source of the income, even if someone else receives the money.
This is based on the principle of "substance over form" — the substance of the transaction matters more than its formal structure when determining tax liability.
Key Principle: "You cannot assign income without assigning the source"
This principle is foundational in tax law. The logic is to prevent tax evasion by transferring income to another person (often someone in a lower tax bracket) while still retaining the asset or source that produces the income.
Leading Case Law: Helvering v. Horst (1940), 311 U.S. 112
Facts:
The taxpayer (Horst) owned negotiable bonds that generated interest coupons.
Instead of giving away the bonds, Horst detached the interest coupons and gave them to his son, who cashed them.
Horst claimed he was not liable for tax on the interest income since he did not receive the money.
Issue:
Was the father (Horst) liable to pay tax on the interest income even though the income was received by his son?
Held (U.S. Supreme Court):
Yes. The court held that the donor (Horst) was still liable to pay tax on the interest income because he retained ownership of the bonds (the source of the income), even though he assigned the right to receive the income to someone else.
Key Principle:
"The power to dispose of income is the equivalent of ownership of it."
Importance:
This case established the principle that income remains taxable to the owner of the source, even if they assign the right to receive it to someone else.
Indian Context: CIT v. K.A. Ramachar (1961) 42 ITR 25 (SC)
Facts:
The assessee was a partner in a firm.
He assigned a part of his share of profits to his wife and minor children through a deed.
He claimed that the income assigned should not be taxed in his hands.
Held (Supreme Court of India):
The income was still taxable in the hands of the assessee because:
The source (partnership share) remained with him.
He only assigned the income, not the source.
Principle Reinforced:
Assignment of income, without transferring the source, does not shift the tax liability.
Exceptions – When Tax Liability Can Shift
Income assignment can be valid for tax purposes if:
The source of income is transferred, e.g., transferring ownership of property or shares.
Proper legal transfer is made, and the new owner assumes the rights and obligations of the asset.
Example:
If A owns a rental property and gifts the property to B (not just the rent), then B becomes the owner of the source, and future rental income is taxable in B's hands.
Difference Between Transfer of Income vs. Transfer of Source
| Aspect | Transfer of Income Only | Transfer of Source (Asset) |
|---|---|---|
| Ownership of Source | Remains with the transferor | Passes to the transferee |
| Tax Liability | Remains with the transferor | Shifts to the transferee |
| Legal Recognition (for tax) | Not accepted for tax avoidance | Accepted |
| Example | Gifting interest income from FD | Gifting the FD itself |
Anti-Avoidance Perspective
The doctrine of income assignment is used as an anti-avoidance tool by tax authorities to ensure that individuals do not escape tax liability by merely restructuring the flow of income.
The tax department often invokes Section 60 and Section 61 of the Income Tax Act, 1961:
Section 60: Income arising to any person by virtue of a transfer without transfer of asset is taxable in the hands of the transferor.
Section 61: In case of a revocable transfer, income is also taxable in the hands of the transferor.
Conclusion
Income assignment without transferring the source is ineffective for avoiding taxation. Courts have consistently held that tax liability cannot be shifted merely by transferring the right to income. The key lies in who owns the source of the income.
This principle ensures that taxpayers cannot evade their tax responsibilities through artificial arrangements, and it upholds the integrity of the tax system.
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