This article continues a series of articles concerning US tax classification of unusual foreign entities; our focus is on the determination whether these entities should be classified as foreign business entities or foreign trusts. Today’s topic is the Hindu Undivided Family, the preferred legal entity for managing family estates for a large number of wealthy Indian families.
A word of caution, the description of the Hindu Undivided Family (“HUF”) provided below is necessarily a general one. This article sacrifices detail for the sake of clarity.
Hindu Undivided Family: Purpose
The main purpose of HUF is to manage family-owned property. I want to emphasize that this is not a property owned by one or two members individually or jointly; rather, the entire family owns the property.
Hindu Undivided Family: Lineal Descendants From a Common Ancestor
HUF is an entity that applies to and gives rights only to lineal descendants from a common ancestor as well as their wives and unmarried daughters. Married daughters are not considered members of their fathers’ families; instead, upon marriage, they become members of their husbands’ families.
These lineal descendants are called coparceners. They have the right to enjoy distributions from HUF and even have a right to demand partition in the HUF property.
Hindu Undivided Family: Management
The head of the family (called “karta”) manages the HUF property on behalf of the family. Usually, karta is a senior male, but recently women also started to occupy this role. Karta is prohibited from contributing property to HUF.
Hindu Undivided Family: Legal Classification Under Indian Law
HUF exists as a separate juridical entity for Indian tax purposes. It is defined on the basis of Hindu personal law. The Hindu personal law states that the joint and undivided family is a normal condition of Hindu society where all members of a Hindu family are living in a state of union.
It is important to emphasize this special legal position of HUF, because all other Indian entities are defined in the Indian company law. HUF is an exception in having Hindu personal law as its legal basis.
Hindu Undivided Family: Potential US Tax Classification
As of the time of this writing, the IRS has not ruled on the proper US tax classification of HUF. Therefore, at this time, we can only speculate about how the IRS will treat HUF under US tax law.
Under 26 CFR §301.7701-4(a) “trust” is defined as an arrangement created by will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules provided in chancery or probate courts. Usually the beneficiaries of such a trust do no more than accept the benefits thereof and are not the voluntary planners or creators of the trust arrangement. However, the beneficiaries of such a trust may be the persons who create it and it will be recognized as a trust if it was created for the purposes of protecting or conserving the trust property for beneficiaries who stand in the same relation to the trust as they would if the trust had been created by others for them. Generally, an arrangement will be treated as a trust if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.
Thus, if it is established that HUF was created for the purpose of vesting trustees responsibility for the protection and conservation of property for beneficiaries and not to carry out business, then, it should be classified as a foreign trust under US tax law. If, however, the facts and circumstances in a particular case indicate that a HUF was established primarily for commercial purposes as opposed to the purpose of protecting or conserving property on behalf of the beneficiaries, then this HUF will most likely be classified as a business entity under §301.7701-2(a).
Additionally, there are certain additional features of HUF that may further support its classification as a foreign trust. For example, the role of karta appears to be analogous to a trustee in most cases, whereas coparceners are likely to be considered beneficiaries for US tax purposes (especially if they do not take any active role in the management of HUF property).
Thus, based on the analysis above, it appears that, in most cases, the IRS is likely to rule that HUF is a trust under US tax law. I want to emphasize the limitation “in most cases”; I believe that a US tax treatment of HUF will depend on the specific facts and circumstances concerning a specific HUF.
Hindu Undivided Family: US International Tax Compliance Implications
The precise US tax classification of HUF may have far-reaching consequences for US international tax compliance of coparceners who are US tax residents (i.e. green card holders or persons who satisfied the substantial presence test) and US citizens (collectively “US Persons”). A whole host of US international tax reporting requirements as well income tax requirements will apply to such individuals.
For example, if HUF is classified as a trust, then coparceners who are US persons may have to file Forms 3520 and 8938 as well as FBARs. Moreover, they may have to deal with the onerous consequences of the “throwback tax” on distributions of accumulated trust income. Other requirements may also apply in this situation.
If, however, HUF is classified as a corporation, then such coparceners may have to file Form 5471 and 8938. If this is a Controlled Foreign Corporation (“CFC”), they will have to deal with all kinds of anti-deferral regimes, including GILTI tax. If this is not a CFC, then the PFIC regime may be a problem. Again, additional requirements may apply in such situations.
If HUF is classified as a partnership, then Form 8865 will have to be filed every year and income from 8865 Schedule K-1 will have to be reported on such a coparcener’s US federal income tax return. Once again, additional requirements may apply in such situations.
Contact Sherayzen Law Office for Professional Help With Your US International Tax Obligations Concerning Hindu Undivided Family
If you are a coparcener who is a US Person, contact Sherayzen Law Office for professional help concerning your US international tax compliance. Sherayzen Law Office is a US-based tax law firm dedicated to helping clients in the United States and throughout the world with their US international tax compliance issues.
We have successfully helped hundreds of Indian clients with their US income tax compliance issues, and we can help you!