Chargeability of income in transfer of assets.

97(1)

All income arising to any person by virtue of a revocable transfer of assets shall be chargeable to income-tax as income of the transferor and shall be included in his total income.

97(2)

The provisions of sub-section (1) shall not apply, if such transfer— (a) is by way of trust which is not revocable during the lifetime of the beneficiary; or (b) and in case of any other transfer, is not revocable during the lifetime of the transferee, and the transferor does not derive any direct or indirect benefit from such income in cases referred to in clauses (a) and (b).

97(3)

Irrespective of the provisions of sub-section (2), all income arising to any person by virtue of such transfer shall be chargeable to income-tax as income of the transferor as and when the power to revoke such transfer arises, and shall than be included in his total income.

Explanation

Section Summary:

This section deals with the taxability of income generated from assets that are transferred to another person. Specifically, it addresses situations where the transfer of assets is revocable (meaning the transferor can take back the assets or control over them). The key focus is on determining whether the income from such transferred assets should be taxed in the hands of the transferor (the person who originally owned the assets) or the transferee (the person who received the assets).

Key Changes:

1. Revocable Transfers: Income from revocable transfers is taxed in the hands of the transferor, not the transferee. This is consistent with prior tax laws but is explicitly clarified here.
2. Exceptions for Irrevocable Transfers: If the transfer is irrevocable (cannot be taken back) during the lifetime of the beneficiary or transferee, and the transferor does not derive any direct or indirect benefit, the income is taxed in the hands of the transferee.
3. Revocation Power: Even if the transfer is initially irrevocable, if the transferor gains the power to revoke the transfer later, the income will be taxed in the transferor’s hands from that point onward.

Practical Implications:

• For Transferors: If you transfer assets but retain the power to revoke the transfer, any income from those assets will be taxed as your income. This prevents tax avoidance by shifting income to others while retaining control.
• For Transferees: If the transfer is irrevocable and you (the transferee) receive the income without the transferor benefiting, the income will be taxed in your hands.
• Trusts: If assets are transferred into a trust that is irrevocable during the beneficiary’s lifetime, the income is taxed in the hands of the beneficiary, provided the transferor does not benefit.

Critical Concepts:

• Revocable Transfer: A transfer where the transferor retains the right to reclaim the asset or control over it.
• Irrevocable Transfer: A transfer where the transferor cannot reclaim the asset or control over it, typically for the lifetime of the beneficiary or transferee.
• Direct or Indirect Benefit: If the transferor receives any benefit (financial or otherwise) from the transferred assets, the income may still be taxed in their hands.

Compliance Steps:

1. Documentation: Maintain clear records of the terms of the transfer, including whether it is revocable or irrevocable.
2. Reporting: Ensure that income from revocable transfers is reported in the transferor’s tax return. For irrevocable transfers, the transferee must report the income, provided the transferor does not benefit.
3. Monitoring: If a transfer becomes revocable later (e.g., due to a change in terms), update tax reporting to reflect the transferor’s liability for the income.

Examples:

1. Revocable Transfer: Mr. A transfers a rental property to his son but retains the right to take it back. The rental income will be taxed in Mr. A’s hands, not his son’s.
2. Irrevocable Transfer: Mr. B transfers shares to a trust for his daughter’s benefit, and the trust cannot be revoked during her lifetime. The dividend income will be taxed in the daughter’s hands, provided Mr. B does not benefit from the income.
3. Revocation Power Arises Later: Ms. C transfers a property to her brother under an irrevocable transfer. However, after 5 years, she gains the power to revoke the transfer. From that point, the rental income will be taxed in Ms. C’s hands.

This section ensures that income from transferred assets is taxed fairly, based on who effectively controls or benefits from the assets.