The Hindu Business Line : Why HUF raises hackles

The Wanchoo Committee way back in 1971 expressed in no unequivocal terms its displeasure with HUF as a separate taxable entity when it said “ ….the institution of the Hindu Undivided Family is widely used for tax avoidance.” Its successors the Bhoothalingam and Raj committees chimed agreement.

The gravamen of the critics of the institution of HUF is that it gives quarter to the majority community not available to the minorities even though one must concede that the Hindu law takes into its fold, Sikhs, Jains and Buddhists as well.

Be that as it may, the point is should HUF be treated as a separate unit of assessment? Being a separate unit taxed on a par with individuals, it enjoys the slab rate of taxation that confers total exemption on the first Rs 1, 50,000 of its income with the next Rs 1,50,000 attracting a 10 per cent tax and the next Rs 2 lakh attracting a 20 per cent tax. It is income in excess of Rs 5 lakh that attracts the maximum rate of tax of 30 per cent in common with individuals.

Some of the experts have opined that criticism against HUF as a separate taxable entity would vaporise, or at least be blunted, if it is charged the maximum rate of tax of 30 per cent on each and every rupee of its income on a par with a partnership firm and company.

Progressive rate

Indeed, it is the pull of the progressive rate that entices one to form a HUF. But then the clamour for treating a HUF on a par with a business entity is flawed inasmuch as often a HUF is not into any business.

Even Margadarsi, the huge chit fund network straddling Andhra Pradesh, cannot possibly derive much mileage from its HUF status for the simple reason that in any case on income beyond Rs 5 lakh it has to fork out a 30 per cent tax on a par with firms and companies.

However, it must be conceded that there is a case for subjecting HUFs deriving business income to a flat rate of 30 per cent tax while leaving those not in any business, given the fact that imposing a stiff tax of 30 per cent on a family consisting of three brothers and their wives and children living under one roof passed down from generation to generation out of the tidy rent received from the tenant of the first floor would be harsh.

Earlier, there was a separate schedule of higher slab rates for HUFs having at least one member having independent taxable income. There was justification for this because unlike the family in the example on hand that has no income apart from the rent from the first floor, individual member(s) in this case can fend for themselves thus requiring no tax indulgence.

Strangely, this scheme was given up without so much as an explanation. At present, a member of a HUF gets exemption under Section 10(2) on any sum received from a HUF of which he is a member because taxing it in his hands would amount to double taxation given that the HUF itself is a separate taxable entity.

If taxing a HUF into business with the maximum rate of 30 per cent is found discriminatory, the Government can perhaps prescribe a formula akin to the one applicable to those having agricultural income in excess of Rs 5,000 in addition to non-agricultural income in excess of the tax-free limit — taxing the non-agricultural income at rates applicable to the aggregate of the two incomes.

If agricultural income can be brought to tax vicariously, though admittedly or arguably with justification, an individual whose taxable income is beefed up by receipts from his HUF, merits the same treatment.

Loopholes Plugged

The Wanchoo Committee and its successors have been heeded by the government in at least insofar as two fertile areas of tax evasion are concerned:

If an individual creates a HUF out of thin air so to speak out of his self-acquired property with a view to splitting his income among multiple taxable entities, his stratagem would fall flat because till partition of the family, the income from the asset thus gifted by him to the family would continue to be assessed as his individual income. In fact this amendment made in 1969 should be hailed as a measure that has knocked the bottom out of creation of charlatan HUFs; and

Partial partition that was resorted to when the HUF grew in size thus warranting maximum rate of tax on the lion’s share of its income has become the thing of past because from 1971 only complete partition is recognised for tax purposes.

With these twin measures, the government has indeed curbed the misuse of HUFs, which cannot be created at will with an eye on reduction of overall tax bill of the family by creating multiple taxable entities. And partition too cannot be done whimsically with an eye on splitting a HUF when it has grown embarrassingly in size.

A surviving loophole?

A HUF, comprising largely senior citizens, may be tempted to go for complete partition. Here is why. Let us say a HUF consist of four brothers all of whom are either septuagenarians or octogenarians. A senior citizen gets a generous and well-deserved immunity from tax on his first Rs 2.25 lakh of income whereas a HUF enjoys tax immunity only on Rs 1.5 lakh.

Let us say this HUF as an income of Rs 9 lakh on which the tax works out to Rs 1.75 lakh at the applicable slab rates. The dramatic change in the slab rates in favour of senior citizens is now going to turn the raison d’etre of a HUF on its head. What was an advantage in an earlier era is now a millstone round the neck.

The four brothers would in all probability agree for a total partition reluctantly so that none of them is required to pay tax. This could be heart wrenching though because no pretence is countenanced — partition of income without partition of property is not recognised by the tax law.

But then, they would nod sagely and agree to a partition because paying a hefty tax is not palatable to anyone least of all to those who are in the twilight of their life. Indeed, they may even bristle at suggestion of exploiting any loophole because for all one knows partition might have been the farthest thing in their minds.

(The author is a Delhi-based chartered accountant.)