Uniform Civil Code: Why it can impact Hindu Undivided Family’s tax benefits

The existence of HUF as a legal entity is based on an acknowledgment of customs by the Raj in India. It was seen as an institution that operated on a strong sense of blood ties and kinship to jointly exercise control over property in Hindu families, and led to business arrangements based on Hindu personal laws rather than contractual arrangements.

As a legal entity, HUF always portrayed a dual identity of a family-backed institution and an income-generating entity solely for the maintenance of the family. Such an arrangement probably played a part in the tax treatment that came to be incorporated in Indian law.

For income tax purposes, an HUF consists of all persons lineally descended from a common ancestor, and includes their wives and unmarried daughters. An HUF has its own Permanent Account Number (PAN) and files tax returns independent of its members. An HUF has a karta who is typically the eldest male person in the family, and manages its day-to-day affairs. Other members are coparceners; children are coparceners of their father’s HUF.

The historical view

The Indian Income Tax Act of 1886 recognised HUF under the term “person”. In an effort to shore up finances for World War I, the British introduced the Super Tax Act, 1917, which recognized HUF as a separate entity for tax purposes for the first time. Super tax was levied in addition to income tax.

The idea of HUF as a distinct category of taxpayer was incorporated in the Income Tax Act, 1922, which formed the basis of the post-independence Income Tax Act, 1961. The law currently in force recognizes HUF as a person under Section 2(31)(ii).

Between the pre- and post-Independence laws, government-instituted committees critically examined the preferential tax treatment for HUFs. The Income Tax Enquiry Report of 1936 flagged the substantial revenue loss owing to the special exemptions for HUFs. The Taxation Enquiry Commission of 1953-54 acknowledged the anomalies created by the preferential tax treatment for HUFs. But since the treatment of HUF under tax law was tied to the legal position of HUF under Hindu personal law, and owing to the pendency of the Hindu Code Bill during that period, the Commission decided not to change the tax position of HUF.

The Justice Wanchoo Committee Report of 1971 explicitly stated that the institution of HUF was being used to avoid tax. In 2018, a Law Commission consultation paper declared that “it is high time that it is understood that justifying this institution on the ground of deep-rooted sentiments at the cost of the country’s revenues may not be judicious”.

The tax treatment

From 1922 onward, additional exemption limit was allowed to HUFs compared to other taxpayers, including individuals, which allowed HUFs to pay lesser tax than other similarly placed taxpayers, despite earning the income in the same manner. This preferential exemption regime was done away with under the Income Tax Act, 1961.

However, HUF as a separate tax entity provides another avenue for Hindu families to reduce their tax burden. Consider: Ram Kumar earns a salary income of Rs 5,00,000 per year, and a rental income of Rs 2,50,000 per year from his ancestral property. The basic exemption of Rs 2,50,000 available to an individual taxpayer is also available to an HUF. Ram Kumar can offer Rs 7,50,000 as his total income to tax, which, after the basic exemption works out to a net taxable income of Rs 5,00,000.

However, Ram Kumar has the option of creating an HUF along with his son and wife. The ancestral property will be treated as HUF property, and any income derived from it will be taxed separately in the hands of the HUF, and not Ram Kumar. This means Ram Kumar will now offer only his salary income of Rs 5,00,000 to tax, and reduce (after the basic exemption of Rs 2,50,000) his net taxable income to Rs 2,50,000 (as against Rs 5,00,000 in the previous option). Further, the HUF will claim a basic exemption of Rs 2,50,000 on its rental income of the same amount, thereby reducing net taxable income to nil.

The creation of the HUF thus results in a legitimately tax-free income of Rs 2,50,000, and a lower effective tax rate for Ram Kumar owing to his net taxable income now being in a lower tax bracket.

Finally, Section 10(2) of the Income Tax Act, 1961 provides that any sum received by an individual as a member of HUF out of the HUF income is not to be included in her total income. This effectively means that Ram Kumar can receive a share of the rental income earned by his HUF but not pay tax on it. This is in contrast to the first option in which Ram Kumar ended up bearing the tax burden of receiving rental income in his own name. Hence, the benefit is not only at the HUF level but also at an individual member level.

Additionally, the HUF is entitled to claim expenses, exemptions, and several deductions from its taxable income, which further reduces the tax burden of a Hindu family.

Not available to all

The concept of HUF is closely tied to the concepts of joint family & coparcenary. This is unique to Hindu personal law (deemed to include Jains, Buddhists & Sikhs).

Interestingly, Kerala abolished the joint family system in 1975 by enacting the Kerala Hindu Joint Family (Abolition) Act, 1975. The Supreme Court adjudicated on the interplay of this abolition with the Income Tax Act, 1961 in CIT vs. N. Ramanatha Reddiar (HUF) (1996) by holding that once the entity of joint family and HUF has been abolished by a competent legislature, the Tax Department can no longer make an assessment on an HUF assessee. As a corollary, the individual taxpayer also can’t avail of tax benefits by creation of an HUF.

However, this benefit of statutory tax planning is not available to a taxpayer for other religions, such as Muslims, Christians, Parsis, etc., which raises concerns over the lack of uniform application of tax laws. De hors the issue of UCC, it can be argued that granting an additional treatment that lowers the tax burden only on the basis of religion is arbitrary, and may fall foul of Article 14 of the Constitution.

Given the above discussion, if and when the issue of UCC is taken up for deliberation, the beneficial tax treatment of HUF will occupy considerable space under the lens of equality before and of tax law, as well as uniformity in application of the tax laws across religions.

The author is a CA, and advocate at the Supreme Court with an expertise in the area of tax law.