A fool judges people by the gifts they give him, says a Chinese proverb. The proverb would not stand its ground in India, thanks to the taxman extending his cold fist towards gratuitous amounts dropped in your pocket.

Over the past years, India has witnessed dramatic changes in its approach towards taxing gifts. The primary legislative intent behind taxing gifts has been to check the money laundering activities, especially tackle huge sums of foreign money making its way to India, in the guise of gifts, which often turn out to be bogus.

In the initial period, taxes were collected from the donor under the Gift Tax Act, which was, however, repealed in 1998. Subsequently, while there were no explicit legislative provisions for taxing gifts, the tax authorities at their own discretion continued to scrutinise their genuineness, and in many cases, taxed such receipts in the hands of the recipient.

This had, however, led to enormous amount of litigation on the grounds that gift, being a gratuitous payment, cannot be considered as income at all and accordingly should not be taxable.

However, effective financial year 2004-05, the finance minister had brought in necessary amendments such that any gratuitous amounts (sparing a few) would be taxable as income from other sources.

Under the latest provisions, any sum of money received without consideration (in excess of Rs 50,000), by an individual or Hindu Undivided Family (HUF), during a financial year, are taxable in the hands of the recipient. For the purpose of computation of the threshold limit of Rs 50,000, the aggregate value of gifts received from all sources by the recipient needs to be considered.

Consider the case of Mithun, who has received a gift of Rs 75,000 from his close friend on Dussehra. Under the latest provisions, Rs 25,000 (being in excess of the permissible limit of Rs 50,000) would be taxable in the Mithuns hands. However, gifts from close relatives have been specifically kept outside the tax net.

Close relatives in relation to the recipient individual mean spouse, any lineal ascendant or descendant of the recipient or that of his/her spouse, brother or sister (and spouse of brother or sister), spouses brother or sister (and their spouses), parents brother or sister (and their spouses).

While the definition of relative has been kept wide enough to cover all kinds of relationships, it can lead to some unintended interesting situations, as mentioned below.

Mithun had received gift of Rs 1,00,000 during the financial year 2006-07 from his uncle. During the current financial year 2007-08, out of huge bonus of Rs 10,00,000 (net of tax) received by him from his company, Mithun gifted Rs 6,00,000 to his uncle, who intended to buy a car.

In the above situation, gifts received by Mithun during financial year 2006-07 would not be taxable since gift from brother of either of the parents would be treated as gift from relative, and accordingly, would not be taxable.

However, gift to his uncle would be taxable in his uncles hands in financial year 2007-08, since there are no specific exclusions for such bona fide cases. It would be advisable for Mithun in such a case to consider buying the car himself and gifting the same to his uncle, since it appears that gifts in kind do not fall within the purview of income tax, on the basis that they cannot be considered as a sum of money for tax purposes.

Accordingly, this would also mean that gifting gold and diamond, which is generally prevalent in India, would not be taxable. This can turn out to be a ready tax planning opportunity for designing gifts between non-relatives, as explained above in Mithuns case. Usage of gift coupons and prepaid vouchers (instead of cash) could also be explored.

Separately, though gifts to relatives are not covered, adequate precaution still needs to be exercised while gifting assets to specified relatives (such as spouse and children) in view of the specific provisions under the Indian domestic tax laws, whereby, income arising on such gifted assets continue to clubbed in the hands of the donor and be taxable in the donors hands.

Additionally, gifts under a will or by way of inheritance, or those received on marriage or from specified trust and institutions are also not taxable. The sparing of gifts in the above bona fide cases from tax is welcome. Overall, a major source of laundering of funds appears to have been plugged by the legislation, while still sparing a few genuine transactions.

However, the taxation of gifts received in some genuine cases such as for medication, academic help, or even occasions other than marriage, from friends, acquaintance, etc, (albeit beyond Rs 50,000) appears to be harsh and should be reconsidered by the legislators.

Pavan Sisodia, Ernst & Young