HUF, NRI & US Taxation
Updated: May 18, 2021
The Hindu Undivided Family has its roots in the ancient Hindu law like the Manu Smriti. This paper is an overview of the Hindu Undivided Family (HUF)—a legal entity embedded in tax, corporate governance and state codification of Hindu personal law in India and it`s probable tax implication under IRS in USA.
Background A Hindu Undivided Family (“HUF”) is a special feature of Hindu society, which today consists of a common ancestor and all of that common ancestor’s lineal descendants together with their spouses and unmarried children. Prior to the amendments to the Hindu Succession Act, 1956 in 2005, only sons could be coparceners, but since then a HUF includes all family members who are Hindus by religion, i.e. sons and daughters whether married or unmarried. The Karta is the manager of the family. Traditionally, the Karta was usually the most senior male. In light of the legal changes enacted in 2005, females can now not only be co-parceners but also Karta’s. The Karta has the power to transfer for value the joint family propertythus binding all of the coparceners in the propertyif such transferis made for legal necessity or for the benefit of the family(i.e. payment of debts for family business). The HUF can pay valid remuneration to the Karta under a valid bonafide agreement for the benefit of the family.
Only joint family property can fund a HUF. Joint family property includes: (i) “Ancestral Property” (as defined below), (ii) property from a partition of a larger HLJF, (iii) property that is acquired with HUF assets, and (iv) separate property that is contributed by a member (although the Indian tax benefits of a HUF described below do not apply to such separate property).
Ancestral property includes any property received by a Hindu male from his father, paternal grandfather or paternal great grandfather. If a Hindu male dies intestate, then the share received by his son is impressed with the character of HUF property in the son’s hands i.e. the wife and children of the son will also have a per capita share in that part of the property. If property is received as a gift or under a Will with a clear direction that it is to be made to the HUF, then it will be so regarded.
A Hindu Coparcenary is a much narrower body within Hindu Undivided Family. Generally speaking, it is a body of individuals who acquires interest by birth in the joint family property. They are the son, grandson and great grandson of the holder of the joint property for the time being. Since 1-9-2005 daughters married or unmarried are now included. The coparcenary, therefore, consists of a common male ancestor and his lineal descendants in the male line within 4 degrees, running from and including such ancestor. No coparcenary can commence without a common male ancestor though after his death, it may consist of collaterals such as brothers, uncles, nephews etc. The essence of coparcenary is community of interest and unity of possession. Birth of a male in a Hindu joint family makes him a
Co- parcener of the HUF. In view of this, all male members automatically become members of the HUF. In addition to that, if a child is adopted then he also becomes a member of the HUF. Moreover, upon marriage, wife becomes a member of her husband’s joint family. After 1-9-2005 daughters are coparceners like sons.
How does a HUF come into existence? The concept of Joint Family under Hindu law as well as the HUF in Income Tax Act, 1961 is broadly the same. HUF is purely a creature of law and cannot be created by an act of parties(except in case of adoption and reunion). A HUF is a fluctuating body, its size increases with birth of a member in the family and decreases on death of a member of the family. The most frequently asked question about HUF is:
How does it come into being? There have to be a minimum of two people to constitute a family. The husband and wife together make up a family. They don't have to wait till they have a baby to constitute their HUF. Every Hindu becomes a member (Coparcener) of an HUF the moment he/she is born out of her mother's womb. A HUF consists of Karta, all the sons and daughters are referred to as Coparceners and wife is a member. An HUF too is inert and dormant without funds. "The million-dollar question indeed is: How to transfer funds into the HUF and keep it floating? A member of the HUF throwing his money into the common pool, or to use that overused cliché' the family hotchpotch, is out of the question, thanks to Section64(2) which would tax the income earned by the HUF on that money in the individual member's hands only. But the clubbing provisions can be bypassed if the HUF invests the money in instruments yielding tax- free income. The tax-free income can then be reinvested to earn even taxable income--income on income is out of the clubbing provisions. Strangers can make gifts but only up to Rs 50,000 (Section 56). A way-out is to receive gifts from members of bigger HUFs, who though your relatives, aren't members of your smaller HUF. A father may make a gift of money to his son's newly-created HUF, clearly specifying in the Gift Deed that the gift is to his son's smaller HUF and not to the son himself. This will keep both Section 64(2) and Section 56(2) at bay. After the HUF has a nucleus of its own and gets going, care has to be taken to keep the HUF's affairs completely distinct from the individual members' affairs. Where the members of the HUF carry on their individual businesses, as they normally do, the distinction between what constitutes the individual's income and what is HUF's income may get blurred. HUF funds and the affairs of the HUF are completely differs from one’s own affairs. One can do his/her business/job freely while having the member of HUF. But HUF income and individual income are different and to be taxed differently. HUF's are allowed to open Savings account although it`s a non-Individual entity. So to have capital in HUF account we should take following steps. 1. Have a HUF Formation Deed. (Banks in India have their own format for this)
2. Have a Gift Deed for receiving funds-Inheritance, Gifts from “Relatives” other than members of this HUF. 3. Apply for permanent account number (PAN) 4. We should have opened a bank account first (not must) but it is advisable so that we can have transaction by cheques. Formation of capital of HUF, Transfer money by gifts etc. to HUF capital keeping in view the clubbing provisions and tax on gifts under Income tax act, Remember there is no Tax on gifts in kind though they may attract clubbing provisions in some cases. NRI & HUF A HUF, whose management, superintendence and control are exercised wholly from within India during the financial year, would be a Resident. From a tax point of view, if it can be shown that all decisions concerning the affairs of the HUF were taken with in India during the relevant year, that HUF will enjoy all benefits also available to a resident individual and the same tax exemptions. A Karta of an HUF can be a non-resident (provided he is a Hindu). However, the residential status of HUF might change under the Income-Tax Act, 1961. An HUF is said to be resident in India if control and management of its affairs is wholly or partly situated in India. The mere fact of absence of Karta from India does not make the family (HUF)a non-resident (unless the decisions concerning the family are taken outside India). PARTITION Every coparcener, including sons and daughters (the latter as of 2005) and grandchildren, has a right to ask for partition of the property, which has to be a total partition. A total partition occurs when all properties of the family are divided among the members, and upon such a partition, the HUF ceases to exist. As noted below, this partition will only be recognized for Indian tax purposes if all property in the HUF is divided. Such total partition has to be approved by Income Tax Authorities and HUF would have to make application to respective Income Tax Officer for approval of total partition. Partial partition would not be approved. The property in a HUF is divided by metes and bounds upon a partition. If there are several branches in a family, each branch takes its share per stirpes, according to the stock with respect to such branch. The property is split into equal shares among coparceners, sons and daughters (including any child in the mother’s womb), the other parent (if one parent has passed away and the children are partitioning) or the other spouse if both spouses are alive (his or her share equals that of a child at the time of partition between parent and children). Within each branch, the members take per capita hut, may, by mutual agreement, take unequally. All coparceners can, after a total partition, agree to reconstitute the HUF by bringing all the property back into the HUF.
WILL / GIFT ISSUES OF A HUF A gift or bequest by a parent to a child to enable the child to establish a new HUF will not automatically cause the property to become joint property; the instrument must specify that it is a gift to the Karta on behalf of the HUF. There is some uncertainty as to whether a lifetime gift to a HUF would be exempted
from the income tax imposed by Indian law on gifts to non- relatives because it is unclear whether a HUF qualifying as a “relative” for this purpose. INDIAN TAX BENEFITS OF HUFS A HUF is treated as a taxpayer separate from the family or the Karta and is eligible for its own tax exemption, separate from the Karta’s individual income tax exemption for Indian income tax purposes. The income exempt ion for individual taxpayers is Rs.2,5O, OOO per year, and Rs 3, 0O, OOO for senior tax payers (between age 60-80) or Rs.5, 00,000/- (Super Senior Citizens (Age above 80). In addition, the HUFs, being a separate entity for tax purposes, can claim a basic exemption of Rs.2, 5O, OOO. Also, a HUF can claim other specific exemptions like Section 80C, 80D etc., rebates, and exemptions with respect to capital gains. Exemptions available to HUF: 80C: Up to Rs.1, 50,000/-. HUF can take out Life Insurance Policies in the name of its members and make payment of the premium, HUF can contribute to the PPF account of its members, invest in 5 Year Bank Fixed Deposits. PPF of HUF is not allowed now but old account continues. 80D: Up to Rs.15-,000/-Rs.20,000/-. payment of Health Insurance Premium for its members (Rs.15000/-) & if the HUF takes out Mediclaim Policy etc., for members of the family who are senior citizens then the amount of Rs. 15,000 will be enhanced to Rs. 20,000.Out of this amount up to Rs. 5,000 can also be included for Preventive Health Check UP. 80DD: Up to Rs.40-,000/-Rs.60,000/-.HUF actually makes payment on medical treatment of a specific disease or ailments as mentioned in the Income-tax Act for the benefit of its members & if such expenditure is made for a member who happens to be a senior citizen, then the deduction to be allowed will be Rs. 60,000. 80G: Donations. Donate to recognised charity trusts and institutions subject to limits of 10% of Gross Total Income. Deduction varies from 50% to 100%. The HUF as per section 24 of the Income-tax Act is also entitled to claim deduction for interest on self occupied house property of Rs. 1,50,000 in a year. The income of the HUF from dividend or shares or Mutual Funds is fully exempt from income-tax. However, under Section 115BBDA (as introduced in the Finance Act, 2016), if aggregate dividend received by an individual/HUF from companies exceeds Rs. 10,00,000, it is liable to pay tax at the rate of 10% on dividend income received in excess of Rs. 10 lakh. Section 115BBDA applies only on dividend income received from domestic companies under Section10(34) and excludes dividend income received from mutual funds under Section 10(35). In case the HUF gives its property on rent to any person, then from the rental income, the HUF will get deduction in respect of entire interest on loan paid by it in respect of the said house property besides statutory deduction of 30% of rental income. If the base of the property of the HUF is high, it may be beneficial to make a total partition of HUF property. Then, each coparcener can receive the property on behalf of his or her own smaller HUF. If a smaller HUF (i.e. a coparcener’s HUF) is in a lower Indian tax bracket, the partition can save Indian tax because it spreads out the income of the larger HUF among the coparceners. A HUF must be fully partitioned in order to take advantage of these income tax benefits; income earned on the property received by a member after partial partition would be combined with the income of the original HUF, as if no partition had taken place. There is Indian income tax savings if one bequeaths property to a descendant’s HUF. If a parent bequeaths property to an adult child as Karta of a new HUF, the child can treat this property as separate from his own property and the income generated from the property in the new HUF will be taxable to the HUF rather than to the parent or the child. As a result, the HUF property and the child’s individual property will receive separate exemptions and also separate deductions for Indian income tax purposes. In the case of a bequest to the future HUF of a minor child or in the case of inheritance by a minor child by way of intestate succession, there are potential tax benefits. Since the recipient is an individual, income from the property is taxed with the recipient’s income, first at his or her parent’s income tax level (since the parents will have control while the child is a minor) and, upon attaining majority, as individual property of the child. Upon marriage, however, at least according to the majority view of the High Courts, the property is treated as Hindu Joint Family Property on behalf of the potential family. The income generated thereafter will be taxable in the hands of the HUF, separate from the individual. Separate exemptions for Indian wealth tax were also available for individual property and HUF property till the time Wealth Tax was in operation but has since been deleted. People having assets that are subject to the Indian Wealth Tax under HUF status stand to gain from the extra exemption under the Wealth Tax Act, 1957. A coparcenary interest in HUF property is not subject to the Indian Wealth Tax. HUFs are most advantageous for individuals with substantial property income. Since two Indian tax returns must be prepared, an HUF makes financial sense only if it would enable a person to reduce tax liabilities on property income. Thus, if an individual wanted to form an HUF with contributions of stock, the HUF would not have much to offer because there is a flat rate of tax on capital gains under the Indian tax laws, and in some instances, no tax at all. (Ex: certain re-investments of long- term net sale proceeds in a residential house.) USA Impact "A significant number of Indian citizens and persons of Indian origin are U.S. income tax residents. Many are also U.S. residents for purposes of U.S. gift, estate, and generation- skipping transfer taxes. Many of these individuals may be coparceners in Hindu Undivided Family property or may inherit property in a Hindu Undivided Family. "
The purpose of this paper is to explain the basic concepts of Hindu Undivided Family property and to discuss how interests in this type of property may be analyzed under U.S. income and U.S. transfer tax rules. Before advising clients on any specific situation, of course, care must always be taken to engage competent counsel from both India and the United States. Applying U.S. tax concepts to the institution of the HUF provides a fascinating example of the analytical challenges that emerge in a globalized world in which one must cross not only boundaries between nations and municipalities but frontiers of time and tradition. UNITED STATES INCOMETAX ANALYSIS A fundamental question for determining the U.S. tax consequences of an HUF is whether the HUF will be treated as a separate entity or whether it would be analogized to a grant or trust under which the person who is viewed as grantor of the property or the person who controls the property (here the Karta) would he considered the owner of the property for United States income tax purposes. Most likely, the IRS will treat a HUF as a separate entity since the Karta cannot be a donor to a HUF and the role of the Karta bears very strong resemblance to the fiduciary responsibilities of a trustee. Most of the U.S. tax rules that cause a trust to be disregarded (Sections 673-677 and 679 of the Internal Revenue Code (IRC)) apply to the person who is the source or donor of the property to the trust and, therefore by definition, do not apply to the Karta because the Karta can never be the donor of HUF property for which the Karta is responsible. However, under IRC Section 678, if a beneficiary of a trust has the right to vest in himself or herself principal or income of a trust, he or she would be treated as the “owner” of the property for U.S. income tax purposes. However, because the Karta’s decisions to make distributions of income, including to himself, must be made in the best interests of the family,we believe that a substantial argument can he made that the Karta does not fall under Section 678 and therefore the HUF should be treated as a separate entity. This gets more support since superintendence, management & control is in India and is treated as “Resident” in India and thus one entity cannot be resident in two countries simultaneously. It should be noted that if an Indian citizen or person of Indian origin who is a United States tax resident establishes a HUF with property that person owns in India and any coparceners are also United States tax residents, assuming the analogy of a trust applies, the donor may he continued to be viewed as owner of the HUF property under Internal Revenue Code Section 679, which makes propertycontributed to a foreign trust by a U.S. person with any U.S. beneficiaries subject to U.S. income tax onthe property as if the donor still held the property in the donor’s own name. If none of the members of the HUF are U.S. residents, then the donor may incur capital gains tax on the unrealized appreciation in the Indian property, under Internal Revenue Code Section 684, which subjects to U.S. capital gains tax transfers of appreciated property by (U.S. tax residents to foreign trusts that do not qualify as grantor trusts under Section 679. If the HUF is treated as a separate entity for U.S. income tax purposes (i.e. not a grantor trust or some other disregarded entity), then the HUF should not be liable to pay U.S. income taxes on such property, even if the Karta is a U.S. income tax resident, because the HUF would be viewed as a non-U.S. entity with non-U.S. source income particularly when superintendence, management & control is in India and is treated as “Resident” in India. A U.S. coparcener’s share of any accumulated income or gains in the HUF that are distributed upon a termination (complete partition) of a HUF could be subject to U.S. income tax under a complex set of rules under which the U.S. coparcener may have to pay an interest charge on the tax that the U.S. coparcener would have paid if the income or gains had been distributed currently. If the Karta has control of any bank accounts in India in connection with the management of the HUF with an aggregate balance of over $10,000, the Karta will have to file annual “FBAR” disclosure reports. If the HUF is not treated as a separate entity but as property of a U.S. donor or Karta, the Karta must include the income of the HUF in his or her income tax return if he or she is a U.S. tax resident. In this event, the taxes paid to India by the HUF should be viewed as being paid by the U.S. donor or Karta and therefore the donor or Karta should be able to claim a credit against the United States income tax for the income tax paid to India. This situation can be analogized to the grantor of a grant or trust receiving a tax credit for non-U.S. taxes paid by the trust. In that case, the grantor still can receive the credit even though, from perspective of the non-U.S. jurisdiction, the trust paid the foreign taxes rather than the grantor. UNITED STATES ESTATE TAX ANALYSIS A common cause of estate tax liability in the United States occurs when a deceased transfers or retains a power over property the decedent gifted or transferred during life. Such transfers are subject to estate tax under Sections 2036 and Section2038 of the Internal Revenue Code. However, those sections will not apply to a deceased U.S. Karta of an existing HUF because the Karta, by definition, did not make a transfer during his or her lifetime, but received this property as an inheritance from another HUF. The fact that the Karta controls the HUF should not cause estate tax inclusion under Section 2041 of the Code (“powers of appointment”) because the Karta does not technically have any individual power over the HUF, but must use the full HUF property in the best interests of the family. However, if the Internal Revenue Service were to successfully argue that the analogy of a HUF to a trust with the Karta having fiduciary duties similar to a Trustee is not correct, a Karta’s coparcenary interest may become subject to the U.S. estate tax. In valuing the interest in the HUF for this purpose, discounts may be applied to the Karta’s interest for the costs of partition, other expenses, and minority discounts. Other coparceners may also have to include in their estate any portion of a HUF to which they could take title by virtue of a right to compel a partition of the HUF. However, if coparceners other than the Karta also have an obligation not to partition except in the interests in all coparceners, there is a good argument that the interest should not be subject to estate tax. The estates of U.S. decedents who die in 2010 are not subject to Federal estate tax but may be subject to state estate tax. Under current law, estates of U.S. decedents dying in 2011 and afterwards are subject to Federal estate tax. UNITED STATES GIFT AND GENERATION-SKIPPING TRANSFER TAX ANALYSIS A transfer of property to a HUF during lifetime by a U.S. citizen or domiciliary will be a gift subject to gift tax. The Internal Revenue Service might argue that the partition of a HUF should be considered a gift by the Karta because the Karta thereby gives up control of the I-TIJF property However, the HUF is always subject to partition and the Karta can only distribute income if it is in the best interests of the initial family. Furthermore, the Karta should not be deemed to have a property interest in any portion of the HUF other than the Karta’s own share. Typically, a United States generation-skipping transfer tax (a “GST tax”) is imposed on a transfer that only benefits a grandchild or more remote descendant, if the transfer had at some time, been subject to U.S. gift tax or estate tax. If the HUF is treated as a separate entity for U.S. Income tax purposes (i.e. Not a grantor trust or some other disregarded entity), then the HUF should not be liable to pay U.S. Income taxes on such property even if the Karta is a U.S. Income tax resident, because the HUF would be viewed as a non-U.S. Entity with non-U.S. Source income. A U.S. coparcener’s share of any current income or gains distributed to coparceners would be subject to U.S. Income tax. A U.S. coparcener’s share of any accumulated income or gains distributed to coparceners before or upon the termination of a HUF could be subject to U.S. Income tax under a complex set of rules under which the U.S. Coparcener may have to pay an interest charge on the tax that the U.S. Coparcener would have paid if the income or gains had been distributed currently (with the gains taxed at the same rates as ordinary income and a possible credit for Indian taxes paid on the distributed income and gains). If the Karta has control of any bank accounts in India in connection with the management of the HUF (or elsewhere outside the United States) with an aggregate balance of over $10,000, the Karta will have to file annual “FBAR” disclosure reports. The karta of a HUF may be treated as a trustee of the Hindu Undivided Family with possible tax implications in the U.S. The income may require to be treated as belonging to a different taxable entity. The clubbing of income of the beneficiary from a trust in the hands of the grantor under Sec. 678 of the U.S. Code cannot possibly be invoked, because karta is not a grant or of the property. If there had been contribution out of the U.S. income by a U.S. resident to form part of HUF property in India, the U.S. resident may well be taxable on the unrealized appreciation of the property under Sec. 679 of the U.S. Code and not otherwise. The income of a joint family in India cannot also be taxable under Sec. 2041 of the U.S. Code, which provides for income over which the resident has power of appointment. None of the contingencies would be applicable in respect of income from joint family property in India held by a resident in U.S. Even if the untenable inference that the karta is a trustee of the HUF property is stretched, the location of trustee in the U.S. should not attract liability when the property is in India. In fact, the karta or any other member cannot be treated as a trustee, merely because of a possible fiduciary angle to his role, because for the same reason, a director of a company, who holds a fiduciary position, cannot be understood as having personal right over the property of the company. No assessment can be made on him as regards the income of the company. Such an inference of likely liability by inference of the karta as a trustee, though expressed in the article merely as a doubt, overlooks the character of the joint family. The income of the HUF has to be treated as that of the Hindu joint family irrespective of death of karta or any other coparcener as long as there is no partition to enable separate right of inheritance of the deceased's share as was pointed out in State of Maharashtra v Narayan Rao Sham Rao Deshmukh (1987)163 ITR 31 (SC). Any inference of liability of Indian income in the U.S. is subject to Double Tax Avoidance Agreement, which should also spare liability on the passive income from investment of the HUF in India. Mulla's Hindu Law would define a joint Hindu family variously described as Hindu Undivided Family or Hindu Joint Family as under: “A joint Hindu family consists of all persons lineally descended from a common ancestor and includes their wives and unmarried daughters. — Commissioner of Income-tax v Luxminarayan (1935) 59 Bom 618, 37 Bom LR 692, 159 IC 424, AIR 1935 Bom 412; Melagiriyappa v Lalithaamama AIR 1961 Mys. 152. A daughter continues to be a member (as co-parcener) of her father's family even after marriage, and becomes a member of her husband's family”. It is further explained that the essence of the Hindu joint family is its unity of ownership in following words: “The essence of a coparcenary under Mitakshara law is unity of ownership. The ownership of the coparcenary property is in the whole body of coparceners. According to the true notion of an undivided family governed by Mitakshara law, no individual member of that family, while it remains undivided, can predicate, of the joint and undivided property, that he, that particular member, has a definite share, one-third or one-fourth. — Appovier v Rama Subba (1886) 11 MIA 75, 89. His interest is a fluctuating interest, capable of being enlarged by deaths in the family, and liable to be diminished by births in the family. Sudarsan v Narasimhulu (1902) 25 Mad 149, 154, 156. It is only on a partition that he becomes entitled to a definite share”. Where a bachelor member gets a share on partition, he holds it on behalf of a potential joint family, so that it becomes joint family property on marriage, a law which has also been settled by the SupremeCourt in Sheela Devi v Lal Chand (2006) 157 Taxman527 (SC). Mayne's “Hindu Law” would understand a Hindu joint family as under: “There is community of interest and unity of possession between all the members and upon the death of any one of them, the others take by survivorship that in which they had during the deceased's lifetime a common possession”.
“According to the true notion of an undivided family in Hindu law, no individual member of that family, whilst it remains undivided, can predicate of the joint and undivided property, that he, that particular member, has a certain definite share.” He has an interest in the coparcenary and on his death this interest lapses to the coparcenary; it passes by survivorship to the other coparceners. He, therefore, has no power to devise it by will, nor is there any question of succession to it. In no part, of the coparcenary property has he left an ‘estate' of his own”. Though there has been some modifications in the Hindu law as regards marriage, adoption and maintenance with recognition of right to a daughter, the concepts of Hindu joint family and what constitutes Hindu joint family property continue to be the same and the position of law for male members of Hindu joint family remains the same. Neither the karta, who is the manager of the joint family nor any other member can predicate his interest in the joint family property. He does not have absolute right to enjoyment and alienation except a right to a share on partition between him and his brothers/ sisters or between him and his children. It is the property for the entire family, so that even an unborn child acquires a right from the time it is in the womb of its mother”.
In the above position of law, a karta or a member of the joint family has no need to report his interest in the joint family property in India in his income-tax return, unless the foreign law has any provision requiring report of such interest in such joint family in a return for the joint family as under the law in India or Sri Lanka.
The institution of the HUF harks back to a time many centuries and even millennia ago, while most of the concepts that undergird current U.S. income, gift, estate and GST tax go back less than a century ago. Applying U.S. tax concepts to the institution of the HUF provides a fascinating example of the analytical challenges that emerge in a globalized world in which one must cross not only boundaries between nations and municipalities but frontiers of time and tradition.
Caution: As per my understanding, US residents are taxed on their world wide income. Any income regardless of how it is derived must be declared to the IRS. In the case of the man as the Karta of an HUF, an alternate opinion would be that his share of the income should be declared when filling US taxes. In case there are no other beneficiaries, then the full amount of income should be declared in USA. Under the DTAA credit for taxes paid should be available in the United States. You need to, however, consult local CPA or US Tax Expert for correct interpretation before arriving at final decision.
Disclaimer: The information provided above is for general information purposes only. Writer assumes no responsibility for errors or omissions in the contents given above. In no event writer will be liable for any special, direct, indirect, consequential or incidental damages or any damages whatsoever, whether in an action or contract, negligence or other tort, arising out of or in connection with the use of contents given above. Services of a competent professional should be sought if legal or other specific expert assistance is required.