Gifts by taxpayers to their close relatives and others were brought under the tax net for the first time in India by the introduction of the Gift Tax Act, 1958 at the instance of Nicolas Kaldor who gave to India its "integrated system of taxation" where he recommended wealth tax, expenditure tax and gift tax to make a more complete picture with the then prevailing income tax on incomes and estate duty on estate passing on death.

This levy on gifts was recommended as a measure of plugging a loophole by gifts by wealthy persons just prior to death thereby escaping estate tax, which could only be levied on wealth passing on death of that person.

Estate duty was abolished in 1985 and ordinarily gift tax should have also been abolished around the same time. However, the government found several positive benefits of retaining gift tax as a source of revenue.  Needless to state, the levy of gift tax was always on the donor of gifts and the tax was linked to the value of the gift.

With effect from October 1, 1998, this donor-based gift tax was abolished and it was proposed to substitute it by donee-based gift tax. However, for several reasons including serious anomalies in the done-based gift tax, gift tax on the donee was not made into law.

However, Mr Chidambaram in his Budget of July 2004 brought back the donee-based tax on gifts through the backdoor by treating certain gifts as income of the recipient donee and recovering income tax on such amounts of gifts received. Thus we now have income tax on the sum of money received after September 1, 2004 as gifts from non-relatives.

Accordingly, gifts from non-relatives are included as income under section 56(2)(v) of the Act with effect from September 1, 2004. The basic exemption initially was Rs 25,000. However, gifts from relatives are exempt without any limit.

The purpose of the provision is to tax primarily gifts from non-relatives including from friends from abroad. This basic exemption of Rs 25,000 received as gift from non-relatives was raised to Rs 50,000 with effect from April 1, 2006. But the catch here is that since the cash gift becomes a part of the individual's income, there is actually no exemption (See Box).

Besides this basic exemption gifts without any limit on the occasion of marriage of the individual receiving the gift are also exempted. It is interesting to note that "on the occasion of marriage" does not mean on the day of marriage but either at the time of or about the time of marriage, marriage being the reason for the gift. Moreover, there is no limit on marriages one may enter into and gifts on all such marriages would be exempt.

Gifts by will or inheritance are also exempt. And finally, the list of relatives for exemption is as under:

• Spouse of the individual;
• Brother or sister of the individual;
• Brother or sister of the spouse of the individual;
• Brother or sister of either of the parents of the individual;
• Lineal ascendant or descendant of the individual;
• Any lineal ascendant or descendant of the spouse of the individual;

Spouse of the person referred to in clauses (ii) to (vi)

The levy of income tax on gifts:

Mr X with salary income of Rs 5 lakh receives gifts during the current accounting year ending March 31, 2008 as under: Rs 75,000 from his friend Rs 2 lakh from his father Rs 5 lakh from his father-in-law What would be the tax liability of Mr X for financial year ended March 2008? Out of above three gifts, only the gift of Rs 75,000 from his friend is taxable as income under section 56(2)(v) while the other two gifts are exempt as gifts from close relatives within the meaning of the section. However, the whole of Rs 75,000 will be chargeable as income and the entire amount of Rs 75,000 would be included in Mr X's income and taxed. In other words, there is nothing like basic exemption of Rs 50,000. Thus, the entire Rs 75,000 and, not just the Rs 25,000 (that is in excess of Rs 50,000 limit) would attract income tax. Thus income tax on Rs 5.75 lakh for accounting year ending March 2008 is Rs 1,24,950 while on Rs 5 lakh, the amount of income prior to gift is Rs 1,03,530, thereby income tax on gift of Rs 75,000 in Mr X's case is Rs 21,420.