HUFs are not used for tax evasion but for tax avoidance/to save the tax within the four corners of the law.
Experts say that there will be little or almost insignificant change in tax revenues.
Illustration: Dominic Xavier/Rediff.com
The law panel, in its report, says that HUFs are being used for tax evasion.
“The special status given to the entity of HUF was only for the purpose of taxation. Now, this status is being used for the evasion of tax only,” it says.
It relies on the Direct Taxes Enquiry Committee Report of 1971 that said HUFs were being used for tax avoidance.
In fact, a 1971 paper published in the Economic and Political Weekly titled “An Agenda for Tax Base Reform” estimated revenue losses in 1958-59 to be Rs 1.47 billion and nearly Rs 300 crore that year.
In order to increase revenues to the Tax Department, the Law Commission recommends abolishing HUFs.
What are HUFs and how are they taxed?
HUF is the legal term given to a joint family in the Indian context and was given a distinct status in income tax law as early as 1886.
The Income Tax Department website clarifies that a HUF is a ‘family which consists of all persons lineally descended from a common ancestor and includes their wives and unmarried daughters'.
The Income Tax Act of 1995, under Section 2(31) includes HUF within the definition of ‘person’, that is an entity required to pay income tax.
According to experts, aside from being a separate tax unit, a HUF is taxed in the same manner as individuals.
“There is no special exemption available to HUFs under tax laws. However, since a HUF is regarded as a separate person (other than the individual Karta of the said HUF), any income earned by the HUF also gets taxed as per the normal income tax slab rates available to an individual,” said Rishabh Shroff, partner at Cyril Amarchand Mangaldas, a law firm.
Amarpal Chadha, Tax Partner & India Mobility Leader, EY India, said: “Any income offered towards tax by a HUF would be eligible for the benefit of the basic exemption, lower slab rates, deductions under Chapter VI-A (of the Income Tax Act).”
Are HUFs guilty of tax evasion?
The Law Commission certainly seems to think so. However, experts disagree.
“There is a difference between tax evasion and tax avoidance.
"Tax avoidance is legitimate, and tax evasion is illegal. HUFs are not used for tax evasion but for tax avoidance/to save the tax within the four corners of the law,” said Balwant Jain, a tax and investment expert.
Amit Singhania, tax partner, at Shardul Amarchand Mangaldas, said to the extent of using a different tax slab, there could be tax evasion.
“However, the department can use other measures to counter that. Two years back, they imposed the General Anti-Avoidance Rules.
"If they think HUFs are being formed to get slab benefit, then HUFs can be disregarded under the GAAR regime,” he added.
Further, according to Shroff, there are checks and balances in the system.
Will the government and the Income Tax Department get more tax revenue if HUFs are abolished?
Although the Law Commission claims that to be the case, experts say that there will be little or almost insignificant change in tax revenues.
“I don’t think there is going to be a significant increase in tax revenue to the I-T department if HUFs are abolished.
"Moreover, I haven’t seen big business houses being incorporated as HUFs,” Singhania said.
Agreeing with this, Shroff said: “This will not affect business houses in any real way.
"Having said this, there will be a minor increase in the revenue collection from smaller taxpayers, as income by HUFs will then be regarded as earned by individual members of the family and they will have to pay tax under higher slab rates for such income.”
In that case, should HUFs be done away with?
Largely, abolishing HUFs could create legal complexities, some experts said.
“If the concept of HUF is abolished under the income-tax law, the taxation of existing HUFs may become complex.
"The income of the HUF would have to be taxed in the hands of the individual,” Chadha said.
Shroff noted the emotional impact of the same.
Striking a different note, Jain said that implementing the Law Commission’s proposal would be difficult because of politics.
“Since in this country everything moves with vote bank considerations and the Hindus constituting a significant proportion of voters, it is very difficult to implement the suggestion of law commission,” he said.