Running a family business with loans or gifts? Know the tax rules

Mint

a day ago

I have two questions regarding laws around investments, business and loans applicable to an HUF: a) can money be lent to an HUF and the same money can be invested? Will income from such investment be taxed in the HUF's hands while the principal remains debt? b) Can an HUF start a business using gifts or loans? Will clubbing apply?
Yes, a Hindu Undivided Family (HUF) can accept loans, and this is one of the most effective ways to introduce funds into the HUF without triggering adverse tax implications—provided the loan is genuine and properly documented. It should clearly state the repayment terms and, if applicable, the interest payable.
If an HUF borrows money and invests those funds (for example, in shares, mutual funds, or fixed deposits), any income earned from such investments—such as interest, dividends, or capital gains—is taxable in the hands of the HUF. The original loan continues to be shown as a liability on the HUF's books.
Moreover, if the borrowed funds are used in a business or to earn taxable income, the interest paid on the loan can be claimed as a deduction, as long as it meets the standard tax rules for expense eligibility.
However, caution is advised when the loan is from members of the HUF. If the loans are frequent, large, interest-free, or never repaid, the Income Tax Department may recharacterize such funds as indirect gifts. This could result in clubbing of income—i.e., taxing the income from such funds in the hands of the lender member instead of the HUF.
To second the second question:
Yes, an HUF can own and operate a business. It is recognised as a separate legal entity under Indian law. However, it cannot engage in professions or services that depend on personal skills or qualifications—since it is not a natural person. For example, an HUF cannot be a lawyer or a doctor.
When it comes to starting a business, the source of funds becomes crucial from a tax perspective:
Gifts: If the business is funded through gifts from members or third parties, the ₹ 50,000 threshold under Section 56(2)(x) of the Income Tax Act applies. Since the HUF has no 'relatives' under the gift tax definition, even gifts from members may be taxable if the value exceeds ₹ 50,000 in a year.
Loans: Loans from members or outsiders are permissible and preferable, as long as they are properly documented. Loans don't attract tax liability for the HUF as long as the transaction is genuine and repayable.
Member's Personal Funds or Assets: If a member—including the Karta or any coparcener—contributes personal funds or assets to start or run the HUF business, clubbing provisions under Section 64(2) of the Income Tax Act come into play. This means that any income generated from such funds may be taxed in the hands of the member, not the HUF. This clubbing continues even if the funds are converted into another form or reinvested.
Given these legal and tax implications, funding a business through properly structured loans is generally more tax-efficient and compliant than using gifts or personal contributions from members. Documentation and intention must be clear to avoid income being clubbed back to the contributor.
CA Vijaykumar Puri, partner at VPRP & Co LLP, Chartered Accountants