If you are stuck in such a situation, here is what to do.

Mr. Rohan Mehra, a resident of Nagpur and a salaried software engineer, recently established a Hindu Undivided Family (HUF) with his family. Seeking ways to optimize his tax liabilities, he considered taking up freelance projects on online platforms like ‘CreativeHub’ and ‘TaskSphere’. His plan was to have all his freelance earnings deposited directly into the HUF’s bank account and file returns for it under the HUF’s PAN. He believed this would allow him to take advantage of the separate basic exemption limit available to an HUF, thereby reducing his overall tax burden. However, he was unsure about the legality of this arrangement and whether the Income Tax Department would accept income earned from his personal skills as HUF income.

Advice in such cases

Understanding the distinction between individual income and HUF income is crucial in such situations. While using an HUF is a legitimate tax-planning tool, its application has specific legal boundaries.

• An HUF is a distinct legal entity for tax purposes, comprising all lineal descendants of a common ancestor. It can own property, earn income, and be taxed separately.
• The primary source of HUF income should be from the investment of HUF funds, assets, or ancestral property. For instance, rental income from an HUF property or profits from a family business funded by HUF capital is considered HUF income.
• Income earned through the personal skills, knowledge, and exertion of a member, without any significant use of HUF funds, is considered the individual’s income. In Mr. Mehra’s case, the income from freelancing is a direct result of his professional expertise and labour, not from the deployment of any HUF assets.
• Attributing such personal income to the HUF can be considered a diversion of income and may be challenged by the tax authorities.
• Consult with Lawyer: The very basic and important step to start is talk to Lawyer / advocate. You should not hesitate in paying his consultation fee i.e. might be in range of Rs. 10,000 to 50,000 depends case to case. He is helping you in this situation of come out. He is expert in the domain and can help you explain the procedure which you might have never explored. A good lawyer can get the issues resolved much faster than you think.

Applicable Sections of Law

This situation is governed by the provisions of the Income Tax Act, 1961. There is no involvement of criminal laws like the Bharatiya Nyaya Sanhita (BNS) unless there is an element of forgery or criminal fraud, which is not the case here. The key legal principles are derived from the Income Tax Act and interpretations by various courts.

• The core principle is that income must be taxed in the hands of the person who earns it. Remuneration or income received by a member of an HUF for services rendered by them in their personal capacity is taxable as their individual income.
• The “clubbing of income” provisions can be invoked by the tax department if an individual tries to divert their personal income to another entity (like an HUF or spouse) to reduce their tax liability.
• Case law, such as in CIT vs. K.S. Subbiah Pillai, has established that if a member’s personal qualifications and exertions are the source of income, it cannot be treated as HUF income, even if some incidental support from the family or its funds was taken.

If you are the complainant

In this context, there isn’t a traditional “complainant.” The opposing party would be the Income Tax Department if they choose to scrutinize your tax returns. If you, as the Karta of the HUF, are facing a query or notice regarding this issue, you should take the following steps:

• Gather Documentation: Collect all relevant documents, including the HUF deed, bank statements for both the HUF and the individual, and contracts from the freelancing platforms.
• Demonstrate the Source of Funds: If you claim an income belongs to the HUF, you must be prepared to prove that it was generated from HUF capital or assets, not from your personal skill.
• Prepare a Clear Response: Your response to any notice should clearly and honestly state the facts of the matter. Misrepresentation can lead to more severe consequences.
• Consult with Lawyer: The very basic and important step to start is talk to Lawyer / advocate. You should not hesitate in paying his consultation fee i.e. might be in range of Rs. 10,000 to 50,000 depends case to case. He is helping you in this situation of come out. He is expert in the domain and can help you explain the procedure which you might have never explored. A good lawyer can get the issues resolved much faster than you think.

If you are the victim

Again, the term “victim” is not directly applicable. Instead, we can look at the potential risks and negative consequences if the tax department rules against your arrangement. If your claim is disallowed, you could face the following:

• Reassessment of Income: The income you credited to the HUF will be “clubbed” with your personal income, and your tax liability will be recalculated at the higher applicable slab rate.
• Demand for Tax Payment: You will receive a demand notice for the differential tax amount.
• Interest: Interest will be charged on the tax due from the original due date of filing the return.
• Penalties: The Income Tax Department may levy a penalty for concealment or misreporting of income, which can be a significant percentage of the tax evaded.
• Consult with Lawyer: The very basic and important step to start is talk to Lawyer / advocate. You should not hesitate in paying his consultation fee i.e. might be in range of Rs. 10,000 to 50,000 depends case to case. He is helping you in this situation of come out. He is expert in the domain and can help you explain the procedure which you might have never explored. A good lawyer can get the issues resolved much faster than you think.

How the police behave in such cases

The police have no role in matters of income tax assessment and disputes. This is a civil matter handled exclusively by the Income Tax Department and appellate bodies like the Commissioner of Income Tax (Appeals), the Income Tax Appellate Tribunal (ITAT), the High Court, and the Supreme Court. Police involvement would only occur in extreme cases of large-scale, organised criminal fraud, which is not relevant to a typical case of routing freelance income through an HUF.

FAQs people normally have

• Can my HUF run a business?
  Yes, an HUF can run a business. However, the business must be established using HUF funds or assets. The profits from such a business are correctly taxed as HUF income.
• What if I use HUF funds to pay for a course that teaches me the freelance skill?
  This is a grey area, but the income is still generally considered personal. The income is generated from your application of the skill, not from the funds themselves. The courts have held that the direct cause of the income is the individual’s expertise.
• Is this tax evasion or tax avoidance?
  Routing personal income to an HUF is generally considered impermissible tax avoidance or even tax evasion, as it involves misrepresenting the nature of the income. Legitimate tax planning involves using legal provisions as intended, whereas this arrangement is often seen as a way to circumvent the law.

What evidence is required?

If your case is selected for scrutiny, the Income Tax Officer will ask for evidence to determine the correct nature of the income. You will need to provide:

• The HUF deed to prove its existence and members.
• Bank statements of the HUF to show the source of its capital.
• Your personal bank statements.
• Invoices and contracts with your freelance clients (e.g., ‘CreativeHub’, ‘TaskSphere’). These will likely be in your individual name, making it difficult to claim it as HUF income.
• Proof of how and where the HUF funds have been invested to generate income.

How long will the investigation take?

An income tax scrutiny or assessment process is time-bound. Typically, the assessment must be completed within a specific period from the end of the relevant assessment year, as prescribed under the Income Tax Act. The process can take several months. If the matter goes into appeals, it can take several years to reach a final resolution through the various appellate levels (CIT(A), ITAT, High Court, etc.).

Advocate Sudhir Rao, Supreme Court of India