The Hindu Business Line : HUF: Bane or Boon?

Surprisingly, the Government carries out any amount of amendment to the law without looking into the revenue loss caused by the recognition of the HUF as a separate taxable entity.

No one can make a profit out of oneself. This is axiomatic in tax law. The concept of the Hindu Undivided Family (HUF) is an exception to this principle. The same person can act as the karta of the HUF and also make profits in his individual name. An HUF member cannot be taxed in respect of any sum which he receives as such member out of the income of the family, even though the family may not have paid the tax on its income. This is what Section (2) of the Income-Tax Act, 1961 lays down.

But income from separate and self-acquired property of a Hindu that has not been thrown into the common stock is assessable as the income of the individual. A partnership arises from contract. The relation of an HUF arises from status. The Indian Partnership Act excludes an HUF carrying on family business as such from the ambit of partnership.

The Toshinwal case

In the Vijay Prakash Toshniwal vs CIT (284 ITR 306; Rajasthan) case, the HUF derived income from contract business. The karta of the HUF sub-let the contract to the individual — the same person, that is — in dual capacity. The question was whether the income from the sub-contract can be included in the hands of the HUF. Toshniwal contended that it was individual income and that he had lent money to the HUF. The income-tax officer (ITO) rejected this contention and assessed the HUF on the entire income, including the income from the sub-contract.

On appeal, the Tribunal held that the HUF cannot be a juristic person. It upheld the action of the ITO clubbing the income from the sub-contract in the hands of the HUF. On further appeal, the Rajasthan High Court decided the matter against the Revenue. It pointed out that the I-T Act itself provides that the HUF is an assessee. In that case, the same person has dual capacity. He can enter into an agreement in different capacity, that is, as karta of the HUF and as an individual. The funds of the individual were utilised for execution of the contract. If the funds advanced by the individual to the karta are taken as a loan, the profit of sub-contract will more or less compensate the interest.

The High Court said: "Therefore, one person can be assessed in dual capacity, i.e., one as karta of the Hindu undivided family and another as in his individual capacity. When one person has dual personality under the Income-tax Act and if the Hindu undivided family sub-let the contract, without there being an adverse tax effect and specially when the income has not escaped as has been found by the Commissioner of income-tax (Appeals) in this case, then in our view the contract given to an individual cannot be said to be a sham transaction as there was no tax evasion in this case.

"Thus, in the facts and circumstances of the present case, we see no substance in the arguments of learned counsel for the Department that the income from contract which has been assessed in the hands of the individual should be assessed in the hands of the Hindu undivided family."

A peculiar entity

Courts have held that there can be a valid partnership even between the karta representing the family and an undivided member of the family in his individual capacity acting as working partner. A single individual by himself cannot form a partnership by acting in two different capacities. There can be no partnership in law between the same individual acting, on the one hand, as the karta of a joint Hindu family, and on the other, as a partner in his individual capacity. But the same individual can enter into a partnership with others in two capacities — in his individual capacity and in his representative capacity as the karta of the HUF.

The HUF is an entity peculiar to the Indian tax law. The law recognises it and there is nothing sham about it. Surprisingly, the Government carries out any amount of amendment to the Hindu law without looking into the revenue loss caused by the recognition of the HUF as a separate taxable entity. The HUF may be a boon to the taxpaying Hindu. But it is definitely a bane to government revenues.

(The author is a former Chief Commissioner of Income-Tax.)