Fee or Salary earned by Karta as Director or Partner Under Person

Fee or Salary Earned by Karta as Director or Partner Under Income Tax: An Indian Law Perspective

The role of a Karta within a Hindu Undivided Family (HUF) often involves managing the HUF's affairs and assets. Sometimes, this management extends to representing the HUF's interests in business entities, leading to situations where the Karta earns income as a director or partner. This article explores the income tax implications of such earnings, specifically addressing whether this income is assessed as the Karta's individual income or as the income of the HUF. We will delve into relevant legal provisions, case laws, and practical considerations under Indian Income Tax law.

Understanding the Karta's Role and Income

The Karta, traditionally the senior-most male member of the HUF, acts as the manager and representative of the family in all its dealings. This includes business activities where the HUF has invested. When the Karta is appointed as a Director of a company or becomes a Partner in a partnership firm representing the HUF, any remuneration received raises the question of its taxability.

The core issue is whether the income is earned by the Karta due to personal skills, expertise, and efforts, or solely by virtue of representing the HUF's investment in the company or firm. The answer dictates whether the income is assessed in the Karta's individual capacity or as part of the HUF's income.

Key Legal Provisions and Principles

Several sections of the Income Tax Act, 1961, are relevant to this discussion:

• Section 4: This section forms the charging section of the Income Tax Act, levying income tax on the total income of the previous year of every person. "Person" under Section 2(31) includes an individual, a HUF, a company, a firm, an association of persons (AOP), and others.

• Section 5: This section defines the scope of total income, specifying that the income must be received or deemed to be received in India, or accrues or arises, or is deemed to accrue or arise to him/her/it in India during such year.

• Section 10(2): This section provides an exemption for 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 section is crucial in understanding the tax treatment of distributions from the HUF to its members.

• Section 61: This section deals with income arising from transfer of assets where the transfer is revocable. It's relevant indirectly, as it reinforces the principle that income is taxed in the hands of the person who genuinely earns it.

The underlying principle is that income is taxed in the hands of the person or entity who effectively earns it. The crucial test is to determine the source of the income and the character in which the income is received.

Income Earned as a Director

When a Karta becomes a director of a company, two scenarios arise:

1. Karta Appointed Solely Representing the HUF's Investment: If the Karta is appointed as a director solely because the HUF owns shares in the company, and the directorship is a way to safeguard the HUF's investment, then the director's fees or salary are generally treated as the HUF's income. In this case, the Karta is essentially acting as an agent of the HUF.

2. Karta Appointed Based on Personal Skills and Expertise: If the Karta is appointed as a director due to their personal qualifications, expertise, and experience, independent of the HUF's shareholding, then the director's fees or salary are generally assessed as the Karta's individual income. The fact that the HUF may be a shareholder is incidental. The Karta is providing services in their personal capacity.

Relevant Case Laws:

• Commissioner of Income Tax v. Bhagwanji Kanji (1978) 113 ITR 764 (Guj): This case emphasized that if the Karta's remuneration is earned because of their personal skills and not solely due to the HUF's investment, it is taxable as the Karta's individual income. The court emphasized the distinction between income earned by virtue of one's own skills and income earned simply due to representing the HUF's interest.

• Commissioner of Income-Tax v. Lakshmiratan Cotton Mills Ltd. (1967) 64 ITR 106 (SC): This case, though not directly on HUF and Karta, highlights the principle that income should be taxed in the hands of the person who effectively earns it through their skill and effort. The Supreme Court considered the issue of beneficial ownership of shares and laid out principles for determination of the correct assessee.

Income Earned as a Partner

Similar principles apply when a Karta becomes a partner in a partnership firm representing the HUF. Again, two key scenarios are relevant:

1. Karta Admitted as Partner Solely Representing the HUF: If the Karta is admitted as a partner solely to represent the HUF's investment and share of profits, and contributes to the firm only in that representative capacity, then the share of profits received from the firm is typically treated as the HUF's income. The Karta acts on behalf of the HUF's contribution.

2. Karta Admitted as Partner Based on Personal Skills and Expertise: If the Karta is admitted as a partner based on their personal skills, knowledge, experience, and contribution to the firm's business, then the share of profits received from the firm is usually assessed as the Karta's individual income. The HUF's role, if any, is merely incidental.

Relevant Case Laws:

• Arun Kumar Jagatramka v. CIT (2011) 335 ITR 195 (SC): This case, while not directly on HUF income, deals with the issue of benami transactions and emphasizes the importance of determining the real owner of income based on evidence and circumstances. This principle resonates with the HUF scenario, where the "real earner" of the income needs to be identified.

• CIT v. Nandlal Gandalal (1960) 39 ITR 305 (MP): Although an older case, it highlights the importance of examining the specific terms of the partnership deed and the actual conduct of the parties to determine whether the Karta was admitted as a partner in their individual capacity or as a representative of the HUF.

Factors Determining Taxability: A Practical Guide

Determining whether the income should be taxed in the hands of the Karta or the HUF involves a careful analysis of the following factors:

1. Partnership Deed/Appointment Letter: The terms of the partnership deed (if the Karta is a partner) or the appointment letter (if the Karta is a director) are crucial. These documents should be examined to see if the Karta is appointed in their individual capacity or as a representative of the HUF.

2. Contribution of Personal Skills and Expertise: Evaluate the Karta's role and contribution. Did the Karta contribute their personal skills, knowledge, and expertise to the business? Was their expertise essential for the role? If so, it supports the argument that the income is earned in their individual capacity.

3. HUF's Investment: Assess the extent of the HUF's investment in the company or firm. Was the Karta's appointment solely based on the HUF's investment? If so, it strengthens the case for taxing the income as the HUF's income.

4. Treatment in Books of Account: How is the income treated in the books of account of the company/firm and the HUF? Consistent treatment supporting one position is helpful, though not necessarily conclusive.

5. Past Practices: What has been the past practice regarding the taxation of such income? Consistency in treatment is generally favored by tax authorities.

6. Beneficial Interest: Even if the income is initially received by the Karta, is there evidence that the Karta has effectively transferred the benefit of the income to the HUF? For example, if the income is immediately deposited into the HUF's bank account.

Tax Planning Considerations

Proper tax planning is essential in these situations. Some key considerations include:

• Clear Documentation: Maintain clear documentation to support the position taken regarding the taxability of the income. This includes the partnership deed, appointment letter, evidence of personal skills and expertise, and details of the HUF's investment.

• Professional Advice: Seek professional tax advice to properly analyze the specific facts and circumstances of the case and determine the appropriate tax treatment.

• Consistency: Maintain consistency in the tax treatment of such income over time.

• Disclosure: Make adequate disclosure of the relevant facts in the income tax return to avoid potential disputes with the tax authorities.

Conclusion

The determination of whether fees or salary earned by a Karta as a director or partner is assessed as individual income or HUF income depends on the specific facts and circumstances of each case. The key factor is to determine whether the income is earned due to the Karta's personal skills and expertise or solely due to representing the HUF's investment. A thorough analysis of the relevant legal provisions, case laws, and practical considerations is essential to ensure compliance with Indian Income Tax law and to optimize tax planning. Consulting with a tax professional is always advisable in these complex situations.