Fee or Salary Earned by Karta as Director or Partner Under Income Tax in India

The income tax treatment of remuneration received by a Karta (manager) of a Hindu Undivided Family (HUF) when acting as a director or partner in a firm or company is a nuanced area of Indian tax law. It hinges on whether the remuneration is received in their individual capacity based on their personal skills or as a representative of the HUF, stemming from investment of HUF funds or utilization of HUF assets. This article delves into the intricacies of this subject, providing a comprehensive overview based on established legal principles and relevant case laws.

Understanding the Basics: HUF and Karta

A Hindu Undivided Family (HUF) is not a creature of contract but arises from status, that is, by operation of Hindu Law. It consists of all persons lineally descended from a common ancestor, including their wives and unmarried daughters. The Karta is the senior-most male member of the family, entrusted with the management of the HUF's affairs and assets. He acts as the representative of the HUF.

The Crux: Individual Capacity vs. Representative Capacity

The key determinant in deciding the taxability of the remuneration lies in understanding whether the Karta earns it in their individual capacity or as a representative of the HUF. If the Karta’s skills and personal qualifications are the primary reason for the remuneration, it’s generally taxed as their individual income. However, if the investment of HUF funds, assets, or the reputation of the HUF is the underlying reason, the income may be treated as HUF income.

Scenario 1: Karta as Director of a Company

When the Karta acts as a director in a company and receives director's fees or salary, the following factors are considered to determine the tax treatment:

• Source of Investment: Did the HUF invest in the company's shares? If yes, the connection between the HUF and the directorship becomes stronger.
• Nature of Remuneration: Is the remuneration primarily for the Karta's technical knowledge, professional skills, or personal expertise, or is it a return on the HUF's investment?
• Extent of HUF's Influence: Does the HUF have a significant influence over the company's affairs due to its shareholding?
• Personal Effort vs. HUF Investment: Was the directorship obtained solely due to the Karta's personal qualifications, independent of any investment or influence by the HUF?

Case Law Examples:

• Commissioner of Income Tax v. Kalu Babu Lal Chand [1959] 37 ITR 123 (SC): This landmark case established the principle that if the income is earned because of an investment of HUF funds, it should be assessed as the income of the HUF.
• Commissioner of Income-Tax v. Shri Niwas Family Trust [2008] 305 ITR 118 (Del): The Delhi High Court held that if the remuneration is earned by virtue of the Karta’s personal skills and not because of any detriment to the HUF, it would be treated as the Karta’s individual income.

Tax Treatment:

• Individual Income: If the Karta earns the director's fees solely due to their personal skills and experience, independent of any HUF investment or influence, the income is taxable in their individual hands under the head "Profits and Gains of Business or Profession" or "Income from Salaries," depending on the nature of the payment (fees or salary).
• HUF Income: If the directorship is secured because of the HUF's investment in the company, or if the HUF's reputation or influence played a significant role, the director's fees can be treated as income of the HUF and taxed accordingly. This would fall under the head "Profits and Gains of Business or Profession" in the hands of the HUF.

Scenario 2: Karta as Partner in a Firm

The same principles apply when the Karta is a partner in a firm and receives salary, commission, or any other form of remuneration. The crucial question is whether the partnership was entered into as an individual or as a representative of the HUF.

• HUF Investment: Did the HUF contribute capital to the partnership firm? This is a strong indicator that the Karta is acting as a representative of the HUF.
• Partnership Deed: Does the partnership deed explicitly mention that the Karta is representing the HUF? While not conclusive, this is a relevant factor.
• Source of Capital: If the Karta introduced capital to the partnership from HUF funds, any remuneration received as a partner is generally treated as HUF income.
• Personal Skill vs. HUF Contribution: The emphasis is on determining whether the Karta's participation and remuneration are predominantly due to their individual skills or the utilization of HUF assets.

Case Law Examples:

• Lakshmiratan Cotton Mills Ltd. v. Commissioner of Income-tax, U. P. [1969] 73 ITR 634 (SC): The Supreme Court emphasized that if a partner invests HUF funds in a partnership, the income derived from the partnership firm, including remuneration, would be considered income of the HUF.
• CIT v. Nandlal Gandalal [1960] 39 ITR 1 (SC): This case highlights the importance of establishing a nexus between the investment of HUF funds and the income earned by the Karta to treat the income as that of the HUF.

Tax Treatment:

• Individual Income: If the Karta joins the partnership based on their personal skills, independent of any HUF contribution or influence, the remuneration is taxable in their individual hands under the head "Profits and Gains of Business or Profession."
• HUF Income: If the Karta joins the partnership representing the HUF, using HUF funds, or if the partnership was formed primarily due to the HUF's reputation, the remuneration is taxed as income of the HUF under the head "Profits and Gains of Business or Profession."

Key Considerations and Burden of Proof

• Burden of Proof: The onus of proving that the income is that of the HUF rests on the assessee (the Karta or the HUF). Clear and convincing evidence must be presented to establish the link between the HUF's investment, influence, or reputation and the income earned by the Karta.
• Documentation: Maintaining thorough documentation is crucial. This includes partnership deeds, company incorporation documents, shareholding patterns, and records of HUF investments.
• Consistency: The treatment of such income should be consistent across assessment years. A change in stance may raise scrutiny from the Income Tax Department.
• Independent Assessment: Each case is assessed based on its specific facts and circumstances. There is no one-size-fits-all approach.
• Professional Advice: Due to the complexity of these matters, it is always advisable to seek professional advice from a qualified Chartered Accountant or tax lawyer.

Specific Provisions of the Income Tax Act, 1961 Relevant to HUFs

While there is no single section explicitly addressing the Karta's income from directorship or partnership, several provisions are relevant:

• Section 4: Charge of income tax on the total income of the previous year of every person, which includes HUFs.
• Section 5: Scope of total income, specifying the incomes included in total income.
• Section 10(2): Exempts any sum received by an individual as a member of a HUF, where such sum has been paid out of the income of the family, or, in the case of any impartible estate, out of the income of the estate belonging to the family. This is related to the distribution of HUF income to its members, and not the income earned by the Karta for services rendered.
• Section 64(2): Deals with clubbing provisions, where income arising directly or indirectly to the spouse or minor child of an individual from assets transferred to them by the individual without adequate consideration is included in the individual's income. This is indirectly relevant, as improper transfer of assets to the HUF to avoid tax can attract scrutiny.

Recent Trends and Developments

Courts are increasingly scrutinizing the claims of HUFs, demanding more concrete evidence to support the contention that the income is indeed that of the HUF. A mere declaration or assertion without supporting documentation is often insufficient. The focus remains on the economic realities of the situation and the substance over form.

Conclusion

The tax treatment of fees or salary earned by a Karta as a director or partner is a complex area requiring careful analysis. The fundamental principle is whether the income is earned due to the Karta’s personal skills and qualifications or as a consequence of the investment, reputation, or influence of the HUF. Maintaining proper documentation, seeking professional advice, and consistently applying the principles outlined above are crucial for ensuring compliance with the Income Tax Act, 1961. The burden of proof lies with the assessee to demonstrate the nexus between the HUF and the income in question. Each case must be evaluated on its own merits, considering the specific facts and circumstances.