Rough Pages

Understanding the Hidden Risks of an HUF

“How do I get my property out of this thing?” said a worried Mr. Jeevanjyot Singh (64) when talking to his legal/financial advisor, Mr. Mehta.

In 1987, Jeevan started his cycle manufacturing business - “Lifeline Cycles” from a shed in Ludhiana. When it was still sputtering along, a friend had casually advised Jeevan, “Invest through your HUF1. Big tax savings.” Jeevan took to the idea and acted on it immediately - with himself as the karta2, his wife, and his teenage son Sonny as members of Jeevanjyot HUF. A few years later the business was booming. Sonny joined in, helped taking it global. Jeevan invested in stocks, land, everything—some in his name, some through the HUF. Then came 2020. The pandemic knocked the wind out of business. Jeevan dipped into the HUF pot again and again to keep the wheels turning. By the time dust settled, the HUF owned most of the company. In 2024, Jeevan decided it was time for Lifeline Cycles to go public. Sonny owned a very insignificant interest. So, he claimed that the HUF (still holding majority stake) be partitioned – thereby giving Sonny a much greater stake! Threatened by legal trouble, Jeevan ran to Mr. Mehta. Unfortunately, all Mr. Mehta could do was console him…

What began as tax planning became a source of ownership disputes and potential litigation. Unfortunately, like Mr. Jeevanjyot many promoters have fallen into (and continue to fall for) the ‘HUF-trap’ and end up using HUFs for investing in real estate or holding ownership stake in their businesses.

HUF is a concept oft-spoken of in the same breath as tax planning. However, it is seen that one knows very little (if at all) about the downsides of using an HUF to hold valuable property.

This article is intended to expound upon the shortcomings of using an HUF and if one wants to, then how can they untangle their property from their HUF. We begin by understanding in brief about basics of HUF, rights of HUF members, the 4 big risks of holding property through HUF and finally how can one “get the property out” of their HUFs.

The Hindu Undivided Family (HUF) is a creature of Hindu Law. A Hindu male with his wife and children automatically constitutes an HUF. In fact, on marriage itself the HUF comes into existence between husband and wife. A Hindu becomes member of the HUF immediately and automatically upon their birth. However, HUF requires more than one family members since the term “family” connotes a group of persons and a single Hindu male/female cannot constitute an HUF. Is it a separate legal entity such that it can sue and can be sued by others in its own name in the eyes of law? No. So, when one says, “This property is owned by the HUF”, it actually means that the HUF members jointly own the property (and their rights as to the property is as per the law). For income-tax purposes, the law has by way of a legal fiction recognised HUF as a separate taxpayer but this is limited solely to taxation. Consequently, it is taxed separately from its members. And this is the very reason for the ever-glorified tax advantage3.

Rights of HUF members

In an HUF, there are coparceners and, (plain vanilla) members. Without going much into the technicalities, coparceners have the following rights –

a. Ownership of the coparcenary property is vested in the whole body of coparceners. (i.e., none of them can sell the property without the consent of others – they literally own it jointly)

b. Only a coparcener can demand partition of the HUF and such partition has to be carried out.

Members (who are not coparceners) do not have any claim over the HUF property and cannot demand partition.

Who all are coparceners? Father, Son, Grandson (son’s son), Great grandson (son of son’s son) and Daughter4. Wife (or in this context, the Mother) is not a coparcener – she is only a member in her husband’s HUF.

Then there is the karta or the senior most male member in the family (the Hindu patriarch). He is the manager of the joint family (consequently the HUF property as well). Karta’s right or interest in the property is same as any coparcener. He is the custodian of HUF income and assets. So, among other things, all dealing of the HUF property would happen through the karta.

Four Major Risks of Holding Property Through an HUF

So, there is a tax advantage alright. But what are the potential downsides which one is silently accepting? While much can be said about this, I would like to highlight four (4) most significant drawbacks of using an HUF.

Risk 1: Lack of Clear Title

Buyers (for any property – be it shares or land or real estate) would want a clear title to pass to them. Unfortunately, any property held by an HUF can be subject to claims from its members and these may, as it turns out, align with the law and find favour with the courts!

For instance, the law states that a karta can dispose of the HUF property only in two cases – (i) legal necessity or (ii) for the benefit of the estate. The onus of establishing the existence of legal necessity is on the purchaser5! Taking this further, a transfer without legal necessity is a voidable transfer at the option of the HUF members6. It is obvious that such right of declaring a transaction void proves to be a potent weapon for a disgruntled relative.

One may take consent from all adult HUF members at the time of sale of HUF property, in which case the courts have held that this certainly strengthens the case to hold the transfer valid7. However, there are still two looming dangers – (i) what if some HUF member does not give a consent when the day comes? and, (ii) what happens if a member was minor at the time of sale and upon becoming a major, he challenges the transaction saying his consent was not obtained? – these are grave issues and the buyer has all the reasons to be apprehensive of buying property from an HUF.

Risk 2: Threat of Sudden Partition

An asset/property holding vehicle should be stable and strong. Any coparcener of an HUF can enforce dissolution of the HUF (also referred to as total/complete partition of the HUF) and thereafter the HUF is bound to be dissolved. This makes HUFs unreliable and unsustainable property holding vehicles. From Jeevanjyot’s story, we see one of the many ways in which this law can deal significant damage in real life.

Risk 3: Global Compliance Nightmares

India has extensive foreign exchange control laws8 which are, though progressively liberalized to a great extent, still quiet restrictive. In that sense, a contravention of forex laws may have serious and costly consequences for the violator. The forex laws significantly lack clarity pertaining to cross-border transactions by HUFs. Inasmuch as, the problem of ambiguity starts from the very fundamental aspect of determining the residential status of an HUF – there is no provision which provides a mechanism for it!

That being said, foreign jurisdictions like USA obviously do not legally recognize the concept of an HUF and, HUF is a unique legal beast which hardly has any contemporary elsewhere in the world. This leads to additional complexities in reporting and paying taxes in such foreign jurisdictions where the family may have migrated.

Risk 4: A Barrier to JV and M&A Deals

As mentioned earlier, an HUF is not a legal person. Accordingly, an HUF cannot enter into agreements in its own name9. This stands in the way of business growth when the cap table of a company has HUFs. For instance, in case it is decided to enter into a joint venture (JV) with a strategic partner, then though one may bind the karta under their Shareholders’ Agreement (SHA or JV Agreement) with the JV partner, it becomes very difficult to manage how it will play out for the HUF members. E.g., what happens if the HUF is suddenly partitioned? How do you ensure that the HUF members are also bound by the SHA? Similar risks prevail in an M&A deal as well.

Is There a Way Out?

Having highlighted the downsides, it is only logical to mention as to how property can be taken out from an HUF. HUF property ceases to be HUF property and becomes individually owned by the HUF members on a partition of the HUF.

HUF partition can be complete or partial. A complete partition of HUF means that the HUF stands dissolved and the separate properties stand divided in the individual names of the HUF members (i.e., the joint ownership comes to an end). There can also be partial partition of HUF wherein certain properties of the HUF are transferred to an individual member or certain members of the HUF cease to be members thereof. Note that the HUF continues to exist for the balance properties/members after partial partition.

So, partition is the way to get the HUF property out. How do you affect such a partition? Through an agreement (i.e., partition deeds) among the coparceners of the HUF. A partition can be written or oral, but a written partition signed by all HUF members (or at least all coparceners) is advisable. Written partition deeds are subject to the applicable stamp duty. If such a partition deed concerns immovable properties then they are also subject to registration with the sub-registrar. Accordingly, this cost must be borne in mind. Note that income-tax laws do not recognize a partial partition, and so even after the partial partition has taken place in respect of some HUF property, the income therefrom continues to be taxed in the hands of the HUF.

Final Thoughts

Almost invariably in all wealth & business succession planning projects for our clients, we come across cases where a good portion of the ownership stake of their company is held through an HUF or maybe a sizeable quantum of land/real estate is held through an HUF. When we explain a few downsides to the clients (as enumerated in this article), they almost always decide to dissolve the HUF if not partition the properties they deem material. Accordingly, this topic was chosen so that this very crucial piece of information reaches a greater audience and helps them in making well-informed decisions going forward.

While the HUF continues to offer some tax efficiency, business owners must weigh the operational, legal, and succession-related risks it poses. In most cases, the costs and uncertainty outweigh the benefits.

In conclusion, it suffices to say that – tax planning should not drive estate planning.

Footnotes

  1. Hindu Undivided Family ↩

  2. The concept of Karta and his powers are briefly explained later in this article. ↩

  3. Benefit of separate basic exemption limit, i.e., no tax upto an income of INR 3,00,000. ↩

  4. After 2005 amendment to the Hindu Succession Act, 1956 Hindu daughters are also coparceners in an HUF. ↩

  5. Arshnoor Singh v. Harpal Kaur, AIR 2019 SC 3098 – The onus for establishing the existence of legal necessity is on the alienee. ↩

  6. Raghubanchmani v. Ambica Prasad AIR 1971 SC 776 ↩

  7. Khushi Ram & Ors. v. Mehr Chand & Ors. AIR 1950 P&H 272 – consents are not proof of legal necessity but may supply any lacuna that may exist in the evidence of legal necessity ↩

  8. Namely Foreign Exchange Management Act, 1999 (FEMA) read with rules, regulations, circulars and notifications thereunder. ↩

  9. Rashik Lal & Co v. CIT, AIR 1998 SC 401 ↩

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