The term “relative” is crucial in the Income-tax Act, 1961, as it directly influences several provisions, including taxation of gifts, income clubbing, and deductions. Defined under Section 2(41), the meaning of “relative” is specific and varies based on the context of its application. In this blog, we break down 6 essential insights about this term, its applications, and its importance in taxation, supported by judicial interpretations and real-life examples.
1. Definition of “Relative” Under Section 2(41)
Section 2(41) of the Income-tax Act defines “relative” in relation to an individual as:
- Husband or wife,
- Brother or sister,
- Lineal ascendants or descendants, such as parents, grandparents, children, and grandchildren.
This definition is strictly limited to immediate family members directly linked to the individual.
Judicial Clarity
In Addl. CIT v. Motor & General Finance Ltd. (2000), the Delhi High Court clarified that “relative” only includes the specified relationships and does not extend to extended family or relatives of relatives (e.g., a brother-in-law or cousin).
2. Tax-Free Gifts: Section 56(2)(x)
Gifts received from a “relative” are exempt from tax under Section 56(2)(x). Here, the definition of “relative” is slightly broader and includes:
- Spouse,
- Siblings of the individual or their spouse,
- Lineal ascendants and descendants (of the individual or their spouse).
Example:
If you receive ₹5,00,000 as a gift from your brother, it is tax-free. However, a similar gift from a cousin would be taxable if it exceeds ₹50,000.
3. Clubbing of Income: Section 64(1)
Income transferred to specific relatives, such as a spouse or minor child, is clubbed with the income of the transferor for tax purposes. This provision ensures that taxpayers cannot reduce their tax liability by diverting income to family members.
Example:
If you transfer rental income from a property to your spouse, the income will still be added to your taxable income under the clubbing provisions.
4. Related Party Transactions: Section 40A(2)
Payments made to relatives for services or goods are scrutinized under Section 40A(2). If such payments are deemed excessive or unreasonable, they may be disallowed as deductions, preventing tax evasion through inflated expenses.
Example:
Paying an inflated consultancy fee to your sibling could lead to the excess amount being disallowed as a business expense.
5. Set-off of Losses for Closely-Held Companies: Section 79(2)(a)
For startups or closely-held companies, maintaining shareholding continuity within “relatives” is essential for carrying forward and setting off losses. This provision safeguards tax benefits for family-run businesses.
Example:
If family members hold shares in a startup, transferring these shares to non-relatives could disqualify the company from carrying forward its business losses.
6. Broader Definitions in Other Contexts
Some provisions of the Income-tax Act define “relative” differently:
- Section 80E: Includes relatives for claiming deductions on education loan interest.
- Section 288: Permits a relative to represent the taxpayer in legal matters.
- Other Statutes: The definition of “relative” under the Maintenance and Welfare of Parents and Senior Citizens Act, 2007 is broader, emphasizing welfare.
Judicial Note:
In Miss Indira Uppal v. Union of India (2022), the Delhi High Court clarified that definitions under other statutes cannot influence the term’s interpretation in the Income-tax Act.
Why Understanding “Relative” is Important
Knowing who qualifies as a “relative” under the Income-tax Act is essential for:
- Tax Planning: Optimize transactions such as gifts, loans, and deductions.
- Compliance: Avoid penalties by adhering to the correct interpretation.
- Avoiding Disputes: Judicial rulings often uphold the narrow definition of “relative,” making clarity essential.
Frequently Asked Questions (FAQs)
Q1. Who qualifies as a “relative” under Section 2(41)?
Under Section 2(41), “relative” includes:
- Spouse,
- Brother or sister,
- Lineal ascendants (e.g., parents, grandparents),
- Lineal descendants (e.g., children, grandchildren).
Q2. Are cousins considered “relatives” under the Income-tax Act?
No, cousins are not considered relatives under Section 2(41). Gifts or payments to cousins may not qualify for exemptions or deductions based on this definition.
Q3. Are gifts from a brother-in-law or sister-in-law exempt from tax?
No, gifts from a brother-in-law or sister-in-law are not exempt unless they fall under the expanded definition in Section 56(2)(x). Always verify if the relationship qualifies under the specific provision.
Q4. What happens if I gift property to my spouse?
If you gift income-generating property to your spouse, any income derived from that property (e.g., rent) will be clubbed with your taxable income under Section 64(1).
Q5. Can I claim deductions on a loan taken for my sibling’s education?
Yes, under Section 80E, education loans taken for a sibling qualify for tax deduction, as siblings fall within the broader definition of “relative” for this provision.
Q6. Does the term “relative” under Income-tax Act include adopted children?
Yes, adopted children qualify as “relatives” under the Income-tax Act since they are treated as lineal descendants.
Conclusion
The term “relative” under the Income-tax Act, 1961, is a key concept influencing exemptions, deductions, and compliance. Understanding its specific definition and context ensures proper tax planning and avoids disputes with tax authorities. For personalized guidance on how this applies to your financial situation, consult a tax professional.
