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The Law Commission of India has recently started a new process Deliberation on the Uniform Civil Code (UCC) and solicit public views on the same. This has led to a debate about the institution of the Hindu Undivided Family (HUF) and its separate treatment under the tax laws of the country.
What is a HUF? Why was it conceived? How does it benefit taxpayers? Will the World Council of Churches influence this institution? explains Deepak Joshi, a chartered accountant and attorney at the Supreme Court.
The existence of the undivided Hindu family as a legal entity depends on the recognition of local customs by the British during the Raj. The HUF was seen as an institution operating on the basis of a strong sense of blood ties and kinship, with the aim of exercising joint control over family property among Hindu families. He made room for family business arrangements to be based on Hindu personal laws rather than contractual arrangements.
In this sense, the HUF as a legal entity has always portrayed a dual identity – one of a family-supported enterprise and the other of an income-generating entity, solely for the purposes of supporting the family. Such an arrangement was complex and unique to the British, which led to its unique treatment under Indian tax laws.
According to the income tax website, a HUF is a family that consists of all people descended from a common ancestor and includes their wives and unmarried daughters. HUF has its permanent account number (PAN) and tax return files independent of members.
The HUF consists of karuta. – Usually the largest male member of the family – with others in the family being involved. The “carta” manages the day-to-day affairs of the HUF. Children are partners in their father’s HUF.
Over the years, there has been a lot of literature produced on the subject that has justified the existence of HUF as a means of protecting the unity and communal nature of Hindu families.
Historical view
HUF has been recognized under Indian tax laws since its inception. Following the Revolution of 1857, the British took control of India from the East India Company. Consequently, the Raj brought a number of new rules and reforms.
India has its own tax code – Income Tax Act of 1886 – which specifically recognized the Hungarian forint under the term “person”. During World War I, in an effort to shore up finances, the British introduced the Super Tax Act of 1917 which recognized the HUF as a separate entity for tax purposes for the first time.
When the income tax system was reformed in 1922, the idea of the HUF as a privileged class of taxpayers was incorporated into the law. The Income Tax Act 1922 formed the basis for the Post-Independence Income Tax Act 1961, which is currently in effect and recognizes HUF as a person under Section 2(31)(2).
Between the pre-independence and post-independence legislation, a number of committees have been set up over the years to critically examine the preferential tax treatment given to the HUF. As early as 1936, the Income Tax Inquiry Report brought up the issue of the large loss of revenue due to the HUF’s special exemptions. Likewise, the Tax Inquiry Committee (1953-1954) acknowledged several anomalies created by the HUF’s preferential tax treatment. As he linked HUF’s treatment under the Tax Act with the legal status of HUF under the Hindu Personal Act, since the Hindu Law Bill was suspended during that period, the committee decided not to effect any change in the tax status of HUF.
However, the 1971 Wanchoo Justice Commission report explicitly stated that the HUF was being used for purposes of tax evasion. This view was also echoed by the Law Commission of India, which issued an advisory paper in 2018, stating that “it is time to understand that justifying this institution on the basis of deep-seated sentiment at the expense of the country’s revenue may not be wise”.
How undivided Hindu families receive beneficial tax treatment
From 1922 to 1961, there was a practice of giving an additional exemption limit to HUF when compared to other forms of taxpayer (including individuals). This resulted in HUF paying less tax than other similar taxpayers, despite earning income in the same way as the others. This preferential exemption system was abolished by the Income Tax Act 1961.
However, this does not mean that HUF is not beneficial for families and individuals. In fact, the HUF as a separate tax entity provides a way for Hindu families to reduce their tax burden in several ways. Take the following example:
Mr. Ram earns salary income of Rs 5,00,000 per annum and also gets rental income of Rs 2,50,000 per annum from leaving his ancestral property. Mr. Ram is married and has a son, Mr. Shyam.
Normally, the basic exemption available to an individual taxpayer is Rs 2,50,000, and he is not liable to pay any tax. This level goes beyond multiple slabs charging multiple tax rates to the individual taxpayer. The same applies to HUF as well. Mr. Ram has the option to file Rs 750,000 as gross income for tax and claim a basic exemption of Rs 2,50,000. This results in his net taxable income of Rs 5,00,000 which will be taxable at applicable slab tax rates.
However, Mr. Ram also has the option to set up a HUF with his son and wife. The ancestral property will be treated as HUF‘s The property and any income generated by the ancestral property will be taxed separately in the hands of HUF and not Mr. Ram. This means that Mr. Ram will now only submit his salary income of Rs 5,00,000 for taxes and claim a basic exemption of Rs. 2,50,000, thus reducing his net taxable income to Rs 2,50,000 (as opposed to Rs 5,00,000 earlier).
Further, HUF will present Rs 2,50,000 as rental income and claim basic slab exemption of Rs 2,50,000, thus reducing the net taxable income to nil. This results in a legally tax-free income of Rs 2,50,000 due to the establishment of the HUF and also a lower effective tax rate for Mr. Ram since his net taxable income is in a lower income bracket than before.
Finally, Section 10(2) of the Income Tax Act 1961 states that any amount an individual receives as a member of HUF from HUF income is not included in his total income. This effectively means that Mr. Ram can receive a share of the rental income earned by his HUF and yet pay no tax on it. This is in stark contrast to the previous option where Bram ended up bearing the tax burden of receiving the rental income in his own name.
In addition, HUF is entitled to claim expenses, exemptions, and multiple deductions from taxable income. This reduces the tax burden of the Hindu family.
HUF problem: Not available worldwide
The concept of HUF is closely related to the concepts of joint family and joint memory. This is unique to Hindu personal law (it is considered to include Jains, Buddhists, and Sikhs). Interestingly, Kerala abolished the joint family system in 1975 by enacting the Kerala Hindu Joint Family (Repeal) Act, 1975. The interaction of this abolition with the Income Tax Act, 1961 has been adjudicated by the CIT High Court vs N. Ramanatha Reddiar (HUF) where it was asserted that once the joint family entity and the HUF are abolished by the relevant legislature, the tax department cannot make an assessment on the HUF any more. As a corollary, an individual taxpayer also cannot take advantage of tax benefits by creating a HUF.
However, the above mentioned feature of statutory tax planning is not available to taxpayers who belong to any religions other than Hinduism. – Muslims, Christians, Persians, etc. This raises a real concern about the lack of uniform application of tax laws to taxpayers based on their religion.
Outside In the UCC case, it could be argued that granting additional tax treatment that relieves the tax burden solely on the basis of debt is arbitrary and may contravene Article 14 of the Constitution. Given the above discussion, if and when the UCC issue is taken up for deliberation, the beneficial tax treatment of the HUF is bound to occupy a large area of the lens of equality before and in tax law, as well as uniformity in the application of tax law across religions.
The author is a Supreme Court attorney with experience in tax law.
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