HUF as partner in partnership firm vis-à-vis Income Tax Act

CA Vinay V. Kawdia

History:

The Hon’ble Supreme Court in Ram Laxman Sugar Mills vs. CIT [1967] 66 ITR 613 observed that a HUF is undoubtedly a “Person” with in the meaning of section 2(31), it is however not a juristic person for all purposes and cannot enter in to an agreement of partnership either with another HUF or Individual. It is open to the manager of a Joint Hindu family, as representing the family, to agree to become a partner with another person. And therefore any remuneration received by Karta would be the personal income of Karta and not the income of the HUF as there is no real connection between the investment of the assets of HUF and remuneration received by Karta.

In Brij Mohan vs. CIT (1993) 201 ITR 831, the Apex court held that where the receipt is a compensation made for the services rendered and not for the return on investment, it is to be treated as individual income of the partner.

However, where members of HUF become the partners in a firm by investment of family funds & not because of any special services rendered by them, [in other words, there is a “real and sufficient” connection between the joint family funds and the salary and commission paid by the firm to the Karta] then the income will belong to HUF. [Lachman Das Bhatia & Sons vs. CIT [2007] 162 Taxman 118 (Delhi), etc.]

Start of Controversy:

ICAI asked the query to MCA specifically in respect of LLP: Whether HUF/ its Karta can become partner/designated partner (DP) in LLP? MCA clarified the matter in view of LLP Act, 2008 vide its letter dated 27.05.16. As per section 5 of LLP Act, 2008 only an individual or body corporate may be a partner in a Limited Liability Partnership. A HUF cannot be treated as a body corporate for the purposes of LLP Act, 2008. [MCA referred to its earlier Circular 13/2013]

MCA further referred the Supreme Court Judgement in Rashiklal & Co. vs. CIT reported in 229 ITR 458 (1998). In view of the said judgement, MCA opined that HUF cannot be a partner but its Karta or any individual of HUF can be a partner in a partnership firm in its individual capacity and not the HUF.

ANALYSIS:

For the purpose of Income Tax Act, as far as allowibility of interest/ remuneration paid to the partner as Karta of HUF is concerned, the ratio of Apex Court judgement in Rashiklal & Company vs. CIT (for A.Y. 1980-81) can’t be applied in isolation without referring to the amendments to the Act [Section 40(b)] thereafter. Hon’ble ITAT, Pune in ITO vs. Bharat Enterprises (2006) 103 TTJ 280 (PUNE) has discussed this in detail after considering the ratio of Apex court in Rashiklal’s case (supra) in the following words:

“……In the light of the above history of amendments, we have examined the issue in hand that whether the remuneration paid to a Karta who was representing HUF, is allowable as an expenditure of the firm because the payment was not to an individual but to a Karta of HUF. In fact, this issue was very much under litigation even at the time of old provision, and it was held that salary paid by a firm to its partner who, as Karta represented an HUF in the firm i,e. in a representative capacity, is nothing but payment to an individual, hence in view of the clear intendment contained in old Section 40(b) it was disallowed.

The Court has observed that the assessment of a firm have to be made strictly in accordance with the provisions of Section 40(b) and the law has to be taken as it was. Since remuneration to partner was not admissible under the old Section 40(b), hence it was held that the said clause expressly prohibits such deduction.

………..however, now the law has taken a U-turn so the ratio laid down in those precedents as on date supports the claim of the assessee. To make it more clear, the ratio laid down was that qua the firm a partner is always an individual may be a Karta representing an HUF. The old section had prohibited the deduction of salary to partner so those decisions were against the assessee-firm, because in those years the claim was in respect of payment to Karta of HUF alleged to be not an individual partner, which was negated. Those very decisions now support the exact identical claim made by assessee firm due to overturned position of law. The old Section 40(b) has now turned-turtle so earlier what was not allowable is now provided in the statute as allowable. So following the interpretation laid down by several courts, the co-ordinate benches have unanimously held that as per the amended Section 40(b) though an HUF is a partner but only through an individual, who functions in his personal capacity qua the firm, hence, payment to such a person has to be allowed as deduction as if paid to an individual partner.”

Recent judicial trend on the subject matter:

An HUF is partner in a firm and remuneration is paid to the Karta of HUF – whether allowable as deduction u/s 40(b) of The Income Tax Act? In whose hands the remuneration is taxable – individual or HUF?

In case of HUF as a partner in firm, generally the remuneration paid to KARTA representing HUF is treated as income of KARTA in his individual capacity for the reason that KARTA is rendering his services in his Individual capacity [Explanation 4 to s. 40(b)].

Though an HUF is a partner but only through an individual, who functions in his personal capacity qua the firm, hence, payment to such a person is allowable as deduction as if paid to an individual partner. [ITO vs. Bharat Enterprises (2006) 103 TTJ 280 (PUNE)]

Recent Judicial Trends:

• Where assessee-firm paid salary to a partner who was actively engaged in conducting affairs of business of firm, it was to be held that requirement of Explanation 4 to Section 40(b) stood complied with, and, thus, assessee-firm would be entitled to deduction in respect of salary paid to said partner even though he was a partner in representative capacity of HUF.[P. Gautam & Co. vs. JCIT [2011] 14 com 79 (Ahd.)]
  

• Salary paid to working partner even though as Karta of HUF, is received as individual and as working partner, hence allowable as deduction while computing income of firm.[CIT vs. Jugal Kishor & Sons [2011] 10 com 82 (All.), Pola Ram & Co. vs. ITO 133 Taxman 75 (Amritsar)]
  

• It is individuals of HUF who indirectly become partner in firm in which HUF is said to be partner and therefore provisions of Section 40(b) that prohibits deduction of payments of commission to any partner who is not a working partner, in computing income under the head PGBP, will not be applicable. Therefore deduction of any commission payable to any individual of HUF shall be allowable.[CIT v. Central Scientific Instrument Corporation [2010] 1 DTLONLINE 149 (All.) Etc.]
  

• Remuneration received by the partner would be assessable in the individual assessment of the assessee when there was no direct nexus between the joint family funds & the salary received and where the salary was paid for the special skill and personal exertion of the Karta. [CIT v. Rajgopal (2003)132 Taxman 39 (Mad.)]
  

• In view of section 40(b)(i) of the Act read with Explanation 4 to S. 40(b), the salary being allowable to a working partner cannot be held to be the salary earned by the assessee HUF on account of its capital contribution. (However interest on capital paid by firm to HUF partner was allowed as income in the hands of assessee HUF) [Subhash Chand Sood (HUF) vs. ITO- ITA No. 123/Chd/2012]
  

• Delhi High Court in Coal India Ltd. vs. M/s Continental & Eastern Agencies [RFA (OS) 37/2003] vide judgement dt. 14.12.2011 after considering all the important Supreme Court precedents on the subject matter further clarified as follows:
  

Fact:

Overall testimony of the evidence read as a whole shows that the witness (party representing respondent firm) categorically claimed himself to be a partner as karta of HUF in the respondent-firm.

Allegations of the appellant:

Mr.V.P.Verma who had instituted the suit on behalf of the respondent was not a partner in the said firm on the date of institution of the suit and also was not authorised to institute, sign and verify the plaint.

Certificate of registration, filed on record by the respondent before the learned Single Judge did not depict Mr.V.P.Verma as a partner in the respondent-firm in his individual capacity. He has been shown as a partner only as karta of Hindu Undivided Family (HUF). Under Hindu Law a karta of HUF cannot enter into a partnership with any other association of persons.

HELD:

There is no substance in the plea of learned counsel for the appellants that Mr.V.P.Verma as karta of HUF could not have entered into any partnership with the respondent firm.

In the case reported as (1967) 66 ITR 613 (SC) Ram Laxman Sugar Mills v. CIT, the Hon’ble Supreme Court has categorically held that it is open to the manager of a joint Hindu Family as representing the family to agree to become a partner with another person. The partnership agreement in that case is between the manager and the other person and by the partnership agreement no members of family, except the manager acquires a right or interest in the partnership. The junior members of the family may make a claim against the manager for treating the income or profits received from the partnership as a joint family asset, but they cannot claim to exercise the rights of partners nor be liable as partners.

The Honble Supreme Court in Rashik Lal’s case observed that a firm is a compendious way of describing the individuals constituting the firm. An HUF directly or indirectly cannot become a partner of a firm because the firm is an association of individuals. Even if a person nominated by the HUF joins a partnership, the partnership will be between the nominated person and the other partners of the firm. If a karta or any other member of the HUF joins a partnership, he can do so only as an individual. His rights and obligations vis-à-vis other partners are determined by the Partnership Act and not by Hindu Law. Whatever may be the relationship between an HUF and its nominee partner, in a partnership, neither the HUF nor any member of the HUF can claim to be a partner or connected with the partnership through a nominee.

From the judgments cited above it stands established that an HUF as such cannot be a partner in a firm but it is competent to the manager or karta acting on behalf of the HUF to enter into a valid partnership with a stranger or with the karta of another family.

In the present case Mr.V.P.Verma had joined partnership with the respondent-firm as karta of HUF and there was no bar on him to join the partnership as karta of HUF.

Thus there is no substance in the arguments of the appellants that the suit filed by the respondent-firm is barred under Section 69(2) of Partnership Act or that Mr.V.P.Verma was not duly authorized to file, sign and verify the pleadings.

CONCLUSION:

If a karta or any other member of the HUF joins a partnership, he can do so only as an individual.  An HUF as such cannot be a partner in a firm but it is competent to the manager or karta acting on behalf of the HUF to enter into a valid partnership with others. Interest paid by firm on capital contribution to HUF is assessable in the hands of HUF, if family funds belonging to HUF are invested in the firm. However, generally the remuneration paid to KARTA representing HUF is treated as income of KARTA in his individual capacity for the reason that KARTA is rendering his services in his Individual capacity. However, where members of HUF become the partners in a firm by investment of family funds & not because of any special services rendered by them, [in other words, there is a “real and sufficient” connection between the joint family funds and the salary paid by the firm to the Karta] then the income will belong to HUF. Further, there are lot of old judgements of High courts/supreme courts on the issue and the same needs to referred carefully having regard to the assessment year involved in those cases since the relevant section 40(b) has witnessed lot of amendments between 1980 to 1992.