Technical Guide on Taxation of HUFs

Prepared by Khusbu M Kinger

Introduction:

An HUF is a family which consists of all persons lineally descended from a common ancestor (up to 4 generations).
A HUF cannot be created under a contract, it is created automatically.
HUF can exist with one coparcener, but for an entity to be taxed as a HUF, it should have at least two coparceners. Exception – At times of partition of larger HUF, it will be taxed as HUF.
For Eg, if HUF consists of only the husband and wife, then there is only one coparcener. Then it will be taxed in the individual capacity of the husband.
Two brothers cannot form a HUF.
HUF deed to create HUF is not mandatory, but recommendatory.
A HUF must obtain PAN in its name.

Members and Coparceners:

A HUF consists of coparceners and members. A person by birth becomes a coparcener and by virtue of marriage becomes member.
After marriage, a daughter ceases to be a member in the parental HUF, but she will continue to be a coparcener in the parental HUF and a member in her husband’s HUF.
For Eg: There is a family consisting of father, mother, son, daughter, son’s wife, son’s child, daughter’s husband and daughter’s child.
The coparceners are father, son, daughter and son’s child. The members are mother and son’s wife.
The daughter, her husband and her child will be a part of husband’s HUF.

Property of Single Member:

When an individual receives an ancestral property at partition, he is assessable as an individual as he cannot be said to have a family.
Still, the character of the property remains unaltered as HUF property for the time being it is not shared with any other member of the family.
He would hold that property only as a property of the HUF.

Assessment of HUF:

An HUF is recognized as a separate assessable entity under the Act, if the following two conditions are satisfied:
There should be a co-parcener ship.
There should be a joint family property which consists of ancestral property, which is inherited from any of its three immediate male members.
Property obtained by daughter from joint family property would be her absolute property. Any income arising would be chargeable in its individual capacity.

Capital Formation:

Property Received on Succession:

On intestate succession, it will be taxed as individual property and not the property of HUF to which it belongs.

On testamentary succession, it will be taxed as HUF capacity provided that there are express or specific terms in the will mentioning the HUF.

Gifts:

If a gift is made with the clear and unequivocal declaration that it is being made for the benefit of the family, such gifted property would bear HUF character.
There is no specific bar to a gift by the father to the HUF of his son, wife and minor children. It may be subject to the clubbing provisions under Section 64, though disapproved by Court, it may lead to litigations.
In such situations, it shall be advisable to receive gifts from grandparents, uncles, and other relations who may not be the members of the family.
If any individual transfers any property/sum of money to his own HUF and the HUF gets an interest/rent, then section 64(2) would be invoked. The income will be included in taxable income of the individual who threw the property/amount in the common hotchpot.
Section 64(2) will not apply to the income generated from income from gifted property.

Investments:

HUF and Partnership:

A HUF in his capacity cannot act as a partner. However, it can request its manager or Karta to join the firm as a partner.
It is even possible for the HUF to request any member or friend or a third party to join the firm as a partner in representative capacity of the HUF.
Contribution of capital is an important factor to decide the stake of a partner in a partnership firm.
If the capital is contributed out of the corpus of the HUF, then the interest from such capital shall be added to the income of the HUF.
If a member contributes capital is in his own capacity, then it is to be treated as the individual income of the member.
Interest on capital in excess of 12% paid to the partner shall be treated as share of profits of the firm. It will not be allowed as deduction in the hands of the partnership firm and will be exempted in the hands of the partner.
In case the income is a compensation made for the services rendered by the individual partner in his capacity (salary/remuneration) and not for the return on investment, it is to be treated as individual income of the partner.
But if his salary/remuneration is really a part of the return for the investments made by the HUF in the partnership firm, the salary income would be added to the income of the HUF.
Then such salary payment shall not qualify for deduction under Section 40(b) for the partnership firm – payment to a working partner.

HUF and Company:

If two or more Hindu Family Firms carry on business if their association is more than 50, then it will be considered as an illegal association.
While calculating the members under the Hindu Family Firms as per the law, we shall ignore the minor members from such family.
HUF cannot hold shares in his capacity, but the shares can be registered in the name of the “person“ as Karta of the HUF.
The HUF cannot be a promoter of the company.
When HUF is the beneficiary of the shares held, the dividend income and capital income shall belong to the HUF.
Any loan given by the Company to the HUF, when shares are registered in the name of the Karta, but the beneficial ownership lies with the HUF, it would be liable to be treated as Deemed Dividend in the hands of the HUF under Section 2(22)(e).

Partition of HUF:

The claim for partition shall be made to the Assessing Officer before the relevant Assessment year.
The AO, on receipt of the claim, must make an enquiry after giving due notice to the members and record a finding whether there has been a partition and if so, the date of partition.
Income of the family from the first date of the previous year till the date of partition is assessed as income of HUF and thereafter as individual income of the members.
The nature of the joint family property on partition shall continue to be property of the HUF as and when the recipient person is married. Hence the character of the property shall remain that of the HUF property.
Partial Partition after 31st December 1978 is not recognized as per Income Tax Act, 1961. It is not possible to create multiple HUFs, but smaller and larger HUFs can exist simultaneously.
Unequal partition by the members of the HUF cannot be considered as gift.
It can be efficient tax planning by giving more share to the less financially sound coparcener and lesser share to the affluent.