Tax dept can scrutinize gift transaction within HUF, so do proper paperwork

I am the karta of a Hindu Undivided Family (HUF) along with both my sons, who have two children each. Can I use HUF funds to give gifts to my children and grandchildren? Can I draw interest-free loan from it? If both of the above are allowed, then what are the tax consequences?

—Name withheld on request

From an income tax perspective, there is no restriction on giving gifts to members of the HUF and receiving interest-free loans from the HUF or the members of the HUF. Further, there should not be any tax implications in the hands of the HUF in providing gifts to individual members.

The tax implications of such gifts in the hands of the recipient individual HUF members is, however, debatable, in view of the provisions of the law and the conflicting judicial precedents in this regard. As per proviso to Section 56(2)(x) of the Income-tax Act, any sum of money or property received by a donee in excess of specified limits (without consideration/for inadequate consideration) is taxable, unless the donor is a relative or in specified circumstances. In the context of an HUF as a donee, the definition of a donor relative means any member thereof. However, in the context of an individual as a donee, the definition of donor relative does not include an HUF. Hence, on plain reading of law, it appears that the gift received by individual HUF members (in excess of specified limits) from the HUF shall be chargeable to tax in the hands of individual members. This has also been upheld in a few judicial rulings. However, certain contradictory rulings have held that such gifts should be tax-free for individual members, as HUF is a group of relatives. Hence, adopting this position that gifts received by an individual HUF member from the HUF is tax-free may be litigious.

Also, there should be no tax implications on the drawing of interest-free loans by you from the HUF, provided it can be established as a genuine transaction. In any case, be mindful that such transactions between relatives may be scrutinized by authorities from a tax avoidance perspective, hence adequate documentation should be maintained to establish their genuineness.

Parizad Sirwalla is partner and head, global mobility services, tax, KPMG in India