The Hindu Undivided Family Taxation Aspects

PREFACE

Hindus constitute a majority of the Indian population. Hinduism, being an ancient religion and a way of life, has customs, traditions and rituals centuries old followed by its members to this day. The joint family system, in which members of one family lived together under a common roof, including married brothers, their children and grandchildren, is in practice even today amongst most Hindu families. Under this system, the members of a family share houses, properties, business, income, wealth, food and their value systems and principles. Therefore, in India, a joint Hindu family is given a separate legal entity status called ‘Hindu Undivided Family’ (HUF) and this status is shared and enjoyed by all members of the family.

HUF is an excellent tax saving device as being a separate legal entity under the tax law it is assessed to tax separately as a distinct legal person. Therefore, a person can file two income tax returns, one in his personal individual capacity and the other in the name of his HUF. This gives him the benefits of dividing his taxable income between two entities and also double deductions and expenses in both capacities. This brings down his total taxable income and tax liability substantially.

I shall be demystifying the HUF world and bring about the salient features of an HUF vis-à-vis the taxation system in India and also illustrate ways and means by HUF status can be effectively used as a Tax Planning tool.

LT CDR ANKIT PANDEYNATIONAL INSTITUTE OF FINANCIAL MANAGEMENT

CONTENTS

The Hindu Undivided Family: Origins

How does it come into being?

Creation of HUF

Frequently asked questions

Concepts of Karta

HUF and Tax Planning

Illustration of tax planning by example


THE HINDU UNDIVIDED FAMILY: ORIGINS

1. The Hindu Undivided Family has its roots in the ancient Hindu law like the Manu Smriti, compiled by a male chauvinist Hindu "Scholar" called Manu, who lived around 200 BC; the Yajnavalikya Smriti compiled by Yajnavalikya and Narada in 100 and 200AD (it merely embellished what had already been laid down by Manu); and Mitakshara codified by Vijneshwara somewhere around the year 1100AD. Mulla, the foremost authority on Hindu law, has described the Mitakshara as "the quintessence of the Smriti law, its precepts and injunctions". Later in the 12th century, there came along another variation of the Hindu law called the Dayabhaga written by one Jimutavahana. The Dayabhaga challenged and deviated from the Mitakshara law in some ways, particularly in relation to succession and inheritance. Under the Dayabhaga system, the father is the sole owner and the exclusive possessor of the joint family property. No member can enforce the partition of the HUF so long as the father lives. But the Mitakshara law stipulates that the property vests in the HUF itself and not in any individual member of the family and therefore can be partitioned within the lifetime of the father. The Dayabhaga law is prevalent in West Bengal and Assam. The Mitakshara law governs Hindus in the rest of the country. Manusmriti completely forbade women to have a share in the family property. The modern Indian government embarrassed by these antediluvian, anachronistic laws has sought to bring them inline from time to time with the egalitarian values of 21st century. On 9th September 2005, the Hindu Succession Act, 1956 was amended to provide that a daughter too could be a coparcener i.e. joint heir, like her brother to the joint family's assets and she too could enforce the partition of the family property to claim her individual share. She continues to be the coparcener in her father's HUF even after she gets married and forms another HUF with her husband. So gender bias has largely been taken out of the HUF laws. A coparcener is one who has a right to demand that the family property be divided and they be handed over their share in the property (or whatever assets the HUF has) in case he or she decides to part ways with the HUF. Not all members of the HUF are its coparceners. The coparceners extends to four degrees down the family hierarchy in the following manner:

1st degree: Holder of ancestral property for the first time. 2nd degree: Sons and daughters (09.09.2005) .3rd degree: Grandsons.4th degree: Great grandsons.

HOW DOES IT COME INTO BEING?

2. The most frequently asked question about HUF is: How does it come into being? To form an HUF, all you have to do is Get Married. The HUF gets created as


soon as you complete the seven circles round the holy fire and become Man and Wife. There have to be a minimum of two people to constitute a family. The husband and wife together make up a family. They don't have to wait till they have a baby to constitute their HUF.

3. Someone may ask, "Can an unmarried man create an HUF?" No, he cannot, if you mean an HUF of which he seeks to be the Karta himself. He can very well be the member of the HUF of his father or grandfather, but to create his own HUF he has to wait till he ties the nuptials. Come to think of it, "Creation of an HUF" is an oxymoron—-a contradiction in terms. Only orphan-and-unmarried Hindus don’t belong to an HUF. Every Hindu becomes a member of an HUF the moment she ejects out of her mother's womb, mode of delivery--C- section or Normal—not withstanding.

HOW ONE CAN CREATE HUF(HINDU UNDIVIDED FAMILY)?

4. The answer is very interesting that the above question is wrong the correct question is How we can create capital for HUF?' We cannot create HUF but can arrange capital for it "Till the time the HUF has an empty kitty, it is like a balloon that no one has yet blown air into. A balloon can rightfully be called a "balloon” only when it swells up with air inside it. Without the air the balloon is inert, dormant. An HUF too is inert and dormant without funds."

CA Sanjeev Bedi (Ludhiana)

Hindu Undivided Family signifies that the undivided family should be of those to whom Hindu Law Applies - Hindu Law applies to Jains, Indian Buddhists and Sikhs also. Muslims and Christians cannot form HUF, as this law doesn’t apply to them.

How to blow funds into the HUF and turn it into a balloon that floats?

5. A member of the HUF throwing his money into the common pool, or to use that overused cliché' the family hotchpots, is out of the question, thanks to Section 64(2) which would tax the income earned by the HUF on that money in the individual member's hands only. But the clubbing provisions can be bypassed if the HUF invests the money in instruments yielding tax-free income. The tax-free income can then be reinvested to earn even taxable income--income on income is out of the clubbing provisions.

6. Strangers can make gifts but only up to Rs 50000 (Section 56). A way-out is to receive gifts from members of bigger HUFs, who though your relatives, aren't members of your smaller HUF. A father may make a gift of money to his son's newly


created HUF, clearly specifying in the Gift Deed that the gift is to his son's smaller HUF and not to the son himself. This will keep both Section 64(2) and Section 56(2) at bay.

7. After the HUF has a nucleus of its own and gets going, care has to be taken to keep the HUF's affairs completely distinct from the individual members' affairs. Where the members of the HUF carry on their individual businesses, as they normally do, the distinction between what constitutes the individual's income and what is HUF's income may get blurred. Some other people, who aren't members of the HUF but are relatives in terms of Section 56(2), can also be found out.

8. Now with everybody comfortable with the question because creating a capital by transfer, gift and all like stuff so to have capital in HUF account we should take following steps. We should have opened a bank account first (not must) but it is advisable so that we can have transaction by cheques. Apply for permanent account number (pan). Formation of capital of HUF, Transfer money by gifts etc to HUF capital keeping in view the clubbing provisions and tax on gifts under Income tax act, Remember there is no Tax on gifts in kind though they may attract clubbing provisions in some cases.

IMPORTANT QUESTIONS ANSWERED

How does an HUF reduce taxes?

9. An HUF is a good tax-cutter because, under the income tax laws, it is treated as a separate entity and assessed to tax as a separate person. Accordingly, an HUF is eligible for all the deductions and exemptions, including the benefit of the basic limit chargeable to tax and wealth tax that’s available to an individual. And so, like an individual, an HUF’s income is tax-free up to Rs 50,000. It also enjoys the exemption under Sections 54 and 54F in respect of capital gains, the deductions under Sections 80CCA, 80CCB, 80D, 80G, 80GG, 80L, and the rebate under Section 88.

What are the rights of the members?

10. The basic difference between a coparcener and a member is that a coparcener can demand partition of an HUF. This is done by way of distributing the HUF property among the coparceners. While each coparcener is then entitled to a share of the property, the members will only be entitled to receive maintenance from the HUF. The karta generally manages the family property, which is regarded as the joint property of all the coparceners.


What income is regarded as HUF income?

11. All the income that arises on the utilisation of the HUF’s assets and on the investment of its funds is regarded as the HUF’s income that is assessed separately and chargeable to tax. Importantly, the income should have been earned using HUF property or funds or property only; if it arises on account of the personal investments of any member, it will generally be regarded as the individual income of the member.

12. If an HUF contributes funds to the capital of a partnership firm in which it is represented by the karta or any other member who represents the HUF, then the profits and interest received from the firm will be treated as HUF income. This is because the income arises on the investment of HUF funds, and so the income belongs to the family. If, however, the partnership firm also pays the karta (or the member who represents the HUF) a salary for efforts put in by him, the remuneration will be regarded as the individual income of the karta/member.

13. It’s important to remember that the same person can be taxed separately as an individual, as well as for and on behalf of the HUF. The two capacities are totally different. And so, the individual and the HUF are totally different units for tax purposes–they are two different assesses. Since an HUF is a separately entity, it can earn income from house property, income from business and capital gains, and income from other sources. However, since emoluments are given for personal skills, an HUF cannot earn income from salaries. An HUF can also carry on a business that is managed on its behalf by the karta. It can also hold shares, securities, jewellery and any other valuable articles or articles, apart from movable and immovable property.

What are the assets of an HUF?

14. Any gift that is given specifically to an HUF can be treated as HUF property. The assets received on the partition of a larger HUF of which the coparcener was a member is also perceived as HUF property is also treated as the property of the HUF. Assets can also be bequeathed to an HUF by way of a will that specifically favours the HUF. A point to be noted: in the absence of a will, the assets received on the death of a benefactor after 1956 (when the Hindu Succession Act came into force) will not be regarded as HUF property, but as individual property, even though such assets have been inherited.

What are the tax benefits?

15. Since the income earned by way of rent under the head ‘income from house property’ or under other heads like ‘capital gains’ is assessed separately in the HUF’s hands, and not clubbed with that of the individual, there can be substantial savings in tax.


16. Again, where an individual cannot carry out certain types of businesses or transactions owing to employment restrictions or other such considerations, one can always explore the possibility of conducting the business in the HUF’s name to utilise the family’s funds for better returns. The HUF is also eligible for the following deductions: Section 80D, for the insurance premium paid on the health of its members; Section 80G, for any donations it makes; Section 80L, in respect of the income on bank and post office deposits, etc. Then, under Section 88, it gets a rebate in respect of the premium paid on life insurance policies for its members, and contributions to the Public Provident Fund accounts of its members, etc.

What are the tax-planning options?

17. One option is to ensure that gifts or inheritances meant for the benefit of all the members of a family are gifted specifically to the HUF, instead of separately to individual members of the family. Since there is no gift tax and estate duty, neither the benefactor nor the recipient will attract tax on such a transfer.

18. The capital of an HUF can also be enhanced by borrowing funds from people who are not members. If the borrowing are specifically in the HUF’s name, and it is thereafter invested in the HUF’s name, the income arising on the investment will be regarded as the income of the HUF. Another option is to transfer individual funds to the HUF and then invest the money in tax-free instruments. Since the income from such investments will be tax-free, it will not be clubbed with the individual’s income. The income arising on the reinvestment of the tax-free income (which may be in taxable income-yielding assets) will also not be clubbed, since only the income arising on transferred amounts is clubbed.

19. Finally, although it is possible for a member of the HUF to transfer his or her individual assets to the HUF, such a transfer isn’t beneficial from the tax point of view. This is because there is no transfer of the tax liability on the income from such assets, due to the tax provisions governing the clubbing of such income with the income of the transferor.

Karta

20. The Karta, which in Hindi means the Doer, is usually the Father, the patter families of the family. He has immense powers over the affairs of the family, more than any other coparcener can wield.

Can a female be the Karta?


21. The answer can't be no in the light of the amendment in the HS Act in 2005. An unmarried daughter, in the unfortunate event of her father passing away, will become the Karta of the HUF if she has no brother.

Can there be an all-female HUF?

22. Yes, there can be. Where a couple has only one issue—-a daughter—-and the husband passes away, the mother-daughter duo can continue the HUF (although a problem may arise after she gets married and becomes a member of her husband's HUF). It has been held by the Allahabad High Court in CIT v. Sarwan Kumar 13 ITR 361 (All) that there can be an HUF consisting of female members only.

23. The Karta can enter into partnership with a firm on behalf of the HUF. But the HUF itself, being not a legal person, can never be a partner in a firm. The fact that Income Tax law grants a PAN to it and treats it as an assessable entity does not bestow upon it the status of a person under the general laws. This has been held to be so in numerous cases. In Ram Laxman Sugar Mills v. CIT 66 ITR 613(SC), the Supreme Court said that "an HUF is undoubtedly a person within the meaning of the Indian Income Tax Act, It is however, not a juristic person for all purposes and cannot enter into an agreement of partnership either with another undivided family or individual".

24. There have been cases where the courts have held that businesses started by individual members after borrowing funds from the HUF were assessable in the HUF's hands, especially where the HUF is already engaged in the same business. So think twice before letting the HUF lend any money to its members and vice versa.In CIT v. Gopal Bansilal Inani (2000) 245 ITR 2 (SC), the Supreme Court disallowed the interest paid to coparceners on the loan the HUF had taken from them as a business expenditure u/s 37(1).

Can an HUF pay remuneration to its Karta?

25. Yes, in Jugal Kishore Baldev Sahai v. CIT 63 ITR 238 (SC), the Supreme Court held that "if remuneration is paid to a Karta of the family under a valid agreement which is bona fide in the interest of and expedient for the business of the family and the payment is genuine and not excessive, such a remuneration must be held to be an expenditure laid out wholly and exclusively, for the purpose of the business and must be allowed as an expenditure under section 10(2)(xv)[corresponding to the present-day Section 37(1)] of the Act".

Partition of the HUF


26. Although the Mitakshara and other Hindu laws do not forbid partial partition of the HUF, the Income Tax law frowns upon it. Under the Hindu law, you may have eliminated the HUF by portioning the property (or what ever assets) of the HUF, but the taxation authorities have invested themselves with powers u/s 171 of the I T Act to continue to treat the defunct HUF as an assessee liable to pay tax unless the partition is effected in strict keeping with the manner laid down in that section. The law wants to dissuade assesses to smash up their bigger HUFs into smaller ones just to create more files to bring down their tax liabilities. Total partition in the context of the IT Act means partition by metes and bounds. "Metes and Bounds", an Anglo-French term, means the boundaries or limits of a tract of land. If the HUF property is physical, it isn't difficult to divide it up, delineating the share of each member. But a non-physical property will have to be divided up amongst the members in such a manner as to comply with Explanation (b) below Section 171(9). Care must be taken that erstwhile coparceners don't simply end up becoming co-owners in the property. For example an FD held by the HUF being partitioned can't be converted into a joint FD of members after partition; if it is, interest on it will continue to be assessed in the HUF's hands. The FD can continue only in one member's name; he can cough up some cash to the other members to compensate them for loss of FD. What metes and bounds partition does is deflate the balloon of the HUF. The Income Tax law will recognize its demise, only when the HUF is stripped naked of each and every layer of the clothing of property—-tangible or intangible, movable or immovable--it had.

HUF AND TAX PLANNING

27. Typically, taxpayers tend to focus on ways of reducing only their own tax burden. This is a normal thing to do, but far greater tax savings are possible when the family as a whole is considered as a tax paying unit. By combining the leeway offered by non-taxpaying members of a family, and judiciously sharing the family income and wealth among all its members, you will find additional ways of reducing your family's tax burden. Here is how:

28. One may like to explore the following possibilities of sharing of income and wealth within the members of your family in order to lower the overall tax liability.

(a) Create an HUF (Hindu Undivided Family) so that the family property and family income is assessed separately from that of the individual members of the family. Tax practitioners can help you in creating an HUF in a perfectly legal manner.

(b) Open as many assessment files as possible for the members of your family, including minor children.


(c) Keep separate accounts for all the gifts received on birthdays and social functions so that they can form the sources of future income through suitable investments.

(d) To avoid problems of the clubbing provisions, you may consider making a gift to your would-be spouse or your son's would-be-spouse. Such pre-marital gifts do not attract the clubbing provisions.

(e) If you are the karta of your HUF, you may make gifts within reasonable limits to the members of your family out of the HUF properties and build their separate assets.

29. Since the income-clubbing provisions apply only so long as your children are minors, you may gift them some assets where the income will be received by them only after they attain 'major' status, e.g. 10-year cash certificates, zero-coupon bonds, etc. Some smart assessees do not gift anything to their spouses. Instead, they organise exchange of assets to avoid clubbing provisions, e.g. a husband exchanges his 1,000 Colgate equity shares with the jewellery owned by his wife.

30. Since the accretions to income arising on the transfer of asset does not attract the clubbing provisions you can gift any amount which can be invested by your wife or daughter-in-law in 9 per cent fixed deposit, etc. It is only the interest on such amount gifted that is included in the income of the individual. The interest on interest does not attract the clubbing provision.

31. Since a genuine loan of any amount to your spouse or children does not attract the clubbing provisions, loan any amount (create evidence to avoid hassles in future) to children and spouse, which they may invest in income earning assets. You can use the Public Provident Fund scheme for building up capital of your minor children. If you have two children you can open two PPF accounts and deposit Rs 15,000 in each account every year. You will get tax deduction under 80C. Moreover, interest on PPF is totally exempt from income tax. Thus, when children become majors, you would have created capital for them while enjoying the tax benefits in the interim.

An Example Of Family-Wide Tax Planning

32. Let us now consider a comprehensive example of tax planning for a family of husband and wife with two children. You can, of course, modify and improve it to suit to your specific income and tax needs. But it offers several key insights into the principles and strategies of tax planning.

Ramesh's gross salary


Mr.Ramesh is an executive working for a well-known company. His gross salary per month is Rs 30,000 made up as under:

Salary Rs 20,000House Rent Allowance Rs 6,000Conveyance Reimbursement Rs 6,000Total Rs 30,000

Ramesh lives in a flat owned by his wife and pays a monthly rental of Rs 8,000. Mrs Gupta pays Rs 12,000 towards municipal taxes.

Under the present rules, the entire house rent allowance received by Gupta is exempt from tax. Similar is the case with conveyance reimbursement, assuming that he spends the entire amount.

Ramesh's take-home pay

Thus, his take-home-pay is as under: RsSalary 20,000Less: PF Contrinution (10%) (-) 2,000HRA 18,000

(+) 6,000 24,000Ramesh's income from house property

Ramesh purchased a flat in his own name by taking a loan of Rs 10 lakh (Rs 1 million) from his employer @ 6% p.a. repayable over 20 years. The annual installment is Rs 50,000 and the interest paid during 2008-2009 is Rs 60,000. Ramesh gets a monthly rent of Rs 10,000 from this flat and pays Rs 20,000 towards municipal taxes.

Thus the income from house property of Ramesh will be calculated as under: RsAnnual value (Rs 10,000 x 12) 120,000Less: Municipal taxes 20,000Net annual value 100,000 RsLess: 30% standard deduction (-) 30,000Interest on loan (-) 60,000 10,000


Ramesh's family expenses and investments

Ramesh's family expenses are about Rs 18,000 p.m. on various household expenses. Ramesh's wife has deposits in banks to the tune of Rs 162,500 earning 8% p.a. There is a Public Provident Fund account opened by Ramesh in his minor son's name. Ramesh deposits varying amounts in the PPF account every year to minimize the tax liability. This year he invested Rs 21,000 in PPF account and contributed Rs 5,000 in Unit-linked insurance plan of the Unit Trust of India.

All the birthday gifts amounting to Rs 50,000 received by his son were pooled up by Ramesh and invested in about 600 shares of Evergreen Infotech Ltd @ Rs 83 in May 2000.

The company gave a bonus issue of 1:1 in 2009. Thus, the number of shares increased to 1,200. In May 2007, the son sold these shares @ Rs 251 per share. He is now 19 years old.

RsSale value (Rs 251 x 1,200) 301,200Less: Indexed cost of acquisition (Rs. 600 x Rs. 83) 551/406 x 49,800

67,586

The acquisition cost of bonus shares is Nil. RsTaxable long capital gains 233,614The long term capital gains are exempt. However

Transaction tax @0.125 % is payable

292

Post tax proceeds 300,908 Thus, by the time he became of major, Ramesh's son had a capital of his own to the tune of Rs 300,908.

The total picture

Let us now look at the total picture: 1. Mr. Ramesh's Income (A.Y. 2009-10) Rs RsSalary (Rs 20,000 x 12) 240,000Income from house property 10,000Total Income 250,000Less: Deductions Section 80C


PF (Rs. 2,000 x 12) 24,000 PPF 21,000 ULIP 5,000 Repayment of Loan (principal)

50,000

100,000Taxable Income 150,000Tax Nil

2. Mrs. Ramesh's Income

Rs Rs i) Income from house property

Annual Value 96,000 Less: Municipal Tax 12,000 84,000 Less: 30% Standard deduction

25,200 58,800

Interest on Bank deposits 13,000Total Income 71,800Tax Nil

3. Master Ramesh's Income

Out of his capital, he invests a sum of Rs 300,000 in 8.5% SLR Power Bonds and earns a tax-free interest of Rs 25,500 p.a.Summary Mr Gupta Mrs Gupta Master Gupta Total Rs Rs Rs RsGross Income 150,000 71,800 25,500 247,300Tax Nil Nil Nil Nil

As Ramesh needs about Rs 18,000 p.m. for household expenses, let us look at the family cash flows:

Cash FlowsMr Ramesh Rs RsInflow Salary + House property income + 408,000


HRA)Outflow PF 24,000 Housing Loan 110,000 Municipal taxes 20,000 ULIP 5,000 PPF 180,000 Net inflow 228,000 Mrs Ramesh 1,000 Master Ramesh 25,500 Total inflow for the fmaily 254,500 Thus, the cash flow position will be quite comfortable leaving a surplus of nearly Rs 38,500. This example of the Ramesh family shows how any family can prosper by careful planning of investments and tax.


Documents

The Hindu Undivided Family Taxation Aspects