Income Splitting: An Attempt to Evade Tax
There seems to be a popular growing belief that one can avoid taxes through different strategies including income splitting. Largely people believe that they can save on taxes through splitting their income. It is nothing but a misconception largely caused by lack of knowledge and faulty advice by consultants possessing imperfect knowledge.
Age Old Saying about Ill-Knowledge
You must have heard of the age old saying about half Mullah and belief. If you have not, I share it with you.
Half mullah is a danger to one’s belief.
Half Mullah can put the belief of a person in danger because of his imperfect knowledge. Similarly a weak tax consultant is going to put you in potential troubles in the longer run. The age old saying about Mullah and Hakeem perfectly applies in tax matters.
Avoiding Higher Income Tax Bracket Rate
It is obvious that many persons are finding ways to escape the higher income tax bracket rates. There are numerous loops that may be utilized for avoiding higher tax rates. One such method, though plugged effectively by legislature, is transfer of income generating assets to family members and other persons.
The legislature and Federal Board of revenue, responsible to collecting different types of taxes, have greater foresight and wisdom. They have already blocked the avenue, of income splitting, by legislating section 90 of the Income Tax Ordinance, 2001.
The Scenario For Explanation of Section 90 On Income Splitting
I shall make an endeavor to explain for you, in plain words, the crux of section 90 of the Income Tax ordinance. We will explain this through a scenario.
You are a happily married person. You have two sons; one is adult and the second is still a minor. Minor means that he has not attained the age of majority which is 18 year in Pakistan. You own certain number of assets and all assets generate income also.
You want to minimize your tax liability. You start contemplating to find ways and means to reduce your tax liability. Suddenly, an idea struck your mind. The idea of splitting your income, through transfer of some assets to your wife or son, to reduce tax liability.
To double check the idea and plan, you meet your tax Consultant and seek his advice. Being weak and having out-dated knowledge, he advises you that you should go for splitting your income to minimizing your tax liability.
He further advises you to transfer your assets to your spouse or son in order for you to achieve your desired goal. But he does not brief you about the pre-requisites or conditions you need to fulfill to achieving tax minimization.
Conditions for Splitting Income Through Transfer of Assets
Although you are at liberty to transfer your assets to anyone you like; but it might not serve your goal of tax evasion. In order to splitting taxable income, and consequent lesser tax liability, you need to meet below mentioned conditions:-
Irrevocable Transfer of Assets
In order to achieve your goal of lesser tax liability through income split, you should transfer to your wife or son permanently till their life time. That transfer agreement must not contain any provision basing on which you could later cancel the transfer in the life time of transferee.
If you transfer an asset to your spouse or child in such a way that transfer can be cancelled due to certain conditions, then income derived from such asset is considered as your income and FBR is going to tax you accordingly.
No Benefit From Assets Income
To succeeding in your goal of lesser tax liability, you must not get any benefit, whether direct or indirect, from the income of the assets that you transferred to your spouse or child.
Receipt of Proper Consideration of the Assets
There is another condition that you need to fulfill. You must have received a reasonable consideration (price) of the assets from the transferee (spouse or minor or other person).
In case you transfer an asset free of cost to Spouse or minor child or any other person for their benefit, FBR is going to treat income generated from that asset as your income and tax you by adding it with your all other income.
Provision of Funds For Purchase of Assets
Similarly, when you provide funds to your spouse or child for purchasing income generating asset; the income arising from that particular asset is also treated as your income and you are going to be taxed accordingly.
However, Transfer of asset to wife is treated valid for the purpose of computing taxable income when the asset is transferred as part of agreement to live apart. Sub section 5 of section 90, throws light upon this.
When you enter into an agreement with your spouse to live apart and transfer the asset to spouse as part of that agreement. The income generated from transferred asset is not treated your income; so you are not liable to pay any income tax on that specific income.
From the above discussion, it is clear that the strategy of income splitting, through transfer of assets, does not work well to evade higher bracket of income tax.
