Income splitting methods

Individual taxpayer pays income tax in progressive taxation manner. The

average rate of tax goes on increasing when income rises. But in flat rate
taxation the average rate of tax remains same even if income increases.
To avoid higher tax rates due to progressive method, some individuals adopt
income splitting methods. They succeed in their efforts if conditions laid
down by law are fulfilled.
We will study 10 methods and conditions for successful transfer of income to
another tax payer.
Number 1
Method: A tax payer transfers his rights to another person to receive income
accruing to him. But does not transfer the ownership of the asset giving rise
to this income. For example: Rent for Plaza and ownership.
The tax liabilities of the two persons
The transferor will pay the tax on the transferred income (RENT) though the
transferee enjoys that income.
Number 2
Method: The taxpayer transfers right to receive income and also transfers
ownership of the asset.
The tax liabilities of the two persons
Income tax on transferred income will be paid by the transferee if two
conditions are fulfilled
a. The transferor has no right to cancel asset transfer deed during
lifetime of transferee.
b. The transferor does not enjoy any benefit from that income.
If these conditions are not met, the transferor will have to pay tax even
though the income is being enjoyed by the transferee.
Number 3
Method: In order to shift the tax liability the tax payer gives right to receive
income and the ownership to the income generating asset to his/her spouse.
The tax liabilities of the two persons
The spouse will pay the tax on transferred income in two situations only:
a. Taxpayer gets adequate consideration for the asset

b. The income transfer is made under the arrangement to live separately

without terminating marriage.
The taxpayer will pay tax on the income being enjoyed by spouse if the
above conditions are not met.
Number 4
Method: In order to reduce the tax liability a taxpayer transfers right to
receive income along with ownership of the income generating asset to
Minor child.
The tax liabilities of the two persons
The minor will pay tax on income if one of these two conditions are met
a. The taxpayer gets adequate consideration to transfer ownership of
asset
b. The minor is the taxpayers married daughter.
The transferor pays tax on the transferred income if none of these conditions
are fulfilled
Number 5
Method: The taxpayer transfers his right to receive income to any person
with the condition that he will use the income for benefit of that person or
spouse or minor children of taxpayer.
The tax liabilities of the two persons
a. The other person will pay tax on income in three situations:
i. Taxpayer gets adequate consideration for transfer of ownership.
ii.
The minor child is married daughter of the taxpayer.
iii.
Income is transferred under an arrangement between spouses to
live apart.
b. The taxpayer will pay the income tax in any other situation though he is
not enjoying the income.
Number 6
Method: Income from business or profession is declared in the hands of a
minor child.
The tax liabilities of parents and minor child:
a. The parents will pay the tax on income declared in minors name
b. The minor will pay the tax on his income if he inherits the business.

Number 7
Method: An investor owning shares and bonds transfers them to his related
person before periodic dividend or interest is declared Thus taxpayer does
not pay any tax on dividend or interest.
After the receiving the dividend or interest the relative transfers back the
investment certificates.
a. The tax liabilities of the two parties
b. The investor will pay tax at a higher rate on dividend or interest
received by the relative.
c. The relative will not pay any tax
Number 8
Method: If the tax rates are decreasing, a private company may not pay
salary to its employee when he/she renders services. The employee does not
pay any tax because he has not received any cash salary. In later years, the
company pays the employees salary and the employee pays tax at a lower
rate.
The tax liabilities of the employee:
If the officer feels that this was a deliberate tax evasion case, he can charge
tax at the rates when services were performed.
Number 9
Method: Two associated taxpayers, like a parent company and its subsidiary
or otherwise related taxpayers transfer goods and services among
themselves at a Non-Market Rates. This is called Transfer pricing. The
purpose is to shift more profit to the taxpayer whose tax rate is lower. In this
way the overall Tax bill of both the taxpayers is reduced.
The tax liabilities of the two taxpayers:
a. The Tax officer can make necessary adjustments to calculate the true
profit of each taxpayer.
b. In real life, making such adjustments is very difficult so taxpayers
cannot be punished.
Number 10
Method: This is similar to the ninth method except one difference. One
Taxpayer is resident in Pakistan and the other is a non-resident. They adopt
transfer pricing which results into more profit for the non-resident and
correspondingly lesser profits for the resident taxpayer. This reduces

Pakistans Tax Collections. Foreign companies especially pharmaceuticals

adopt this method.
Tax liabilities of the two taxpayers:
a. Tax officers have the power to re-adjust accounts of the taxpayers to
ensure Pakistan gets its due share in income tax
b. Because of nature of transactions and non-availability of proper
evidence the tax officers find it difficult to re-adjust