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Monday, 18 August 2014

CAPITAL FORMATION OF HINDU UNDIVIDED FAMILY (HUF) UNDER INCOME TAX ACT

After creating on HUF file the assessee wants to increase the capital of HUF, known as capital formation. That too needs to be done within the parameters of law and in the light of the principals enunciated by the Supreme Court.

Some of the modes for creating capital in HUF file are:

(1). Ancestral funds through partial partition.
(2). gift of ancestral funds.
(3). Gift from third parties.
(4). Property received under “will” of any party.
(5). Self- generation, i.e., earning of income in HUF.
(6). Throwing in by a member of an HUF.

(i) Ancestral funds through partial partition

            Receipt of ancestral funds through partial partition has been very effectively used in past. Usually the properties of an HUF where partially partitioned so that the coparcener in whose HUF the funds are to be required is given the largest share whereas other coparceners/members are given meager amount since unequal partition is permissible under the Hindu law. This kind of partitions were held to be valid. In this way the funds belonging to a greater HUF were carved out and stamped as capital of smaller HUF, meaning there by that the funds belonging to the father’s HUF were brought in to the son’s HUF.

However, in 1978 this planning was plugged and it was provided under s. 171, that such partial partitions, in case of  “hitherto assessed HUF” , shall not be recognised under the Income – tax Act. Hence this route has now become practically useless in cases where the HUF has been once assessed to income-tax. However, it may still may be a worthwhile avenue for those HUFs, which have never been assessed (not hitherto assessed) to income-tax.

A question may arise whether unequal partition would result in “gift” or not? The supreme Court in CGT vs. N.S. Getti chettiar (1972) 82 TTR 599 (SC); TC 35r. 730 has held that unequal partition of the properties of on HUF would not fall within the definition of “Gift” under the Gift-tax Act. Incidently the gift-Tax Act has also been abolished from 1st October, 1998.
  

(vi)          Receiving gift of ancestral funds

It has been held in Narendrenath’s case [(1969)] 74 ITR 190 9 (SC): TC 65R. 557]
Those funds which were ancestral and which are received on partition by the coparcener would become the property of such a coparcener’s HUF. Applying this principle if an HUF gifts reasonable amounts to the HUF of one its coparceners then the donee coparcener would receive the amount for and on behalf of his HUF. In other words the funds so received in gift, bearing the stamp of ancestral funds would continue to remain so in the hands of the coparcener also, i.e., it would be treated as ancestral funds in the coparceners HUF. Once it is ‘ancestral funds’ in the coparceners HUF, relaying on principles laid down in surjital’s case [1976 CTR (SC) 1470 : (1975) 101 ITR 776 (SC): TC 37R. 132] The incoming generated from such uncestral funds would be taxed in the hands of coparcener’s HUF and not in his individual status. Since the above –referred gift by a bigger HUF to smaller HUF is not covered by term “partition” as defined in Explanation under section 171, it would not be effected by the rigours of section 171(9). Further now since the gift-tax in case of above- mentioned gifts.
                                          
However it may be noted that the karta of an HUF has got power only to make gifts or reasonable amounts. This aspect of powers of Karta vis-à-vis making a gift should be considered.

(vi)          Gifts from outsiders

While considering the issue of gift from outsider it may be noted that gift from outsiders to an HUF is held to be a valid gift in the hands of HUF has held by the supreme court in Pushpa Devi vs. CIT 1977 CTR (SC) 348: (1977) 109 ITR 730 (SC): TC 37R. 168. However it is important to note that the donor should in clear term state that the gifts has been given to an HUF. There should be no ambiguity left in this matter.




Now let as consider a situation where on one hand we have a family, which comprises of husband wife son and minor daughter. On the other hand we have a family, which comprises of husband, wife and two unmarried daughter i.e., there is only one coparcener.

In the first mentioned family composition, where there are two coparceners the income generated from the gifted funds will be assessed in the hands of HUF.

But if the family has a composition of the second type viz. only one coparcener, then has held in surjital chabda’s case (supra) through the gifted funds belongs to the HUF, since there is only one coparcener, the income of such gifted funds would be taxable in the hands of the solo coparcener. However there can be a contrary view also as stated above. Does this mean that for such families the doors or shut for formation of capital in HUF?
Let us consider an example where the family consist of husband, wife and unmarried daughter, which we shall refer as smaller HUF however the husband has a brother and a father who are still surviving meaning there by the father’s family to which we shall refer as bigger family is in existence, in the father family there is a father, two sons and let us say the mother. Let us presume that this bigger family has no JUF corpus if the genuine third party gift is received in the bigger HUF i.e. fathers HUF. After the receipt of gift if an unequal partial partition is made of the bigger HUF and substantial amount is received by the smaller HUF and substantial amount is received by the smaller HUF then such amount received on partial partition shall become the corpus of smaller HUF. Now applying the principles laid down in the case of narendranath vs. CIT (supra), since the corpus of the smaller HUF bears the stamp of ancestral property i.e., property owned by the bigger HUF where the husband i.e., sole coparcener of smaller HUF will also be considered as ancestral property. This in turn would mean that it shall not be hit by the ratio laid down in sujital’s case the ratio laid down considering the fact that the property received in the hands of the family did not bear the stamp of ancestral property.

However, before resorting to this kind of unequal partition, one will have to examine whether the bigger HUF has been hitherto assessed or not. This is because section 171(9) of the income – tax Act 1961 provides that if an HUF is already assessed to tax as on HUF, then if any partial partition is made after 31st December, 1978, then such partially partition shall not be recognised by the assessing officer and the assessment of income arising out of the partially partitioned property shall be made in the hands of the HUF. Incidently it should be noted that if on HUF is assessed as HUF, then unless the clime of partial partition is recognised by the assessing officer, the income will continue to be assessed in the hands of the HUF.the various sub-section of section 171 provide for the machinery to assess the income and recover the tax, interest, penalty, etc., section 171 provides a fiction where by , through income belongs to the smaller HUF, it is deemed to bethe income of bigger HUF, it is deemed to be the income of bigger HUF is liable to pay the Tax.
           

(iv)Gift to HUF under a will

Another mode for creating corpus in the HUF is through a will. A parson can bequeath his or her property through his or her will. In a valid will if it has been clearly mentioned that the property shall bestow, let us say, upon the son’s HUF then the property so received by that person, shall belong to his HUF.

(v).Earning of income in HUF

The Supreme Court has also set the principle that if the income is generated out of the investment of funds of HUF, it is HUF income is attributable to be the skills and exertion and the coparcener it is to be taxed in the hands of such coparcener.
For example ordinary commission is paid for rendering of services. There fore, commission is earned on account of exertion of skill labour by on individual. Thus commission income in normal circumstance could not be said to have been earned by HUF, where it can be established on facts, that the assets or funds of the HUF were utilised or at stake in earning the commission income. If the commission is earned as a DEL CREDRE agent, where the agent guarantees the realization of sale, the funds of the agent are at stake, in such a case if the commission agent is on HUF and HUF as sufficient funds, then the commission so earned would have to be taxed in the hands of the HUF.

(vi)          Throwing in by a member of an HUF.

The last mentioned mode viz. capital formation by throwing in or blending of personal property is no more attractive (expect in few exceptional cases) because of the clubbing provisions embedded in section 64(2) and hence it is not discussed in this article however, in given set of facts this route may still be beneficial.