Tax Benefits of creating HUF

Date: 19-5-2015

What is a HUF?

The Income Tax Act 1961 provides that a HUF (Hindu Undivided Family) is separate unit like an individual and is too assessed accordingly. A HUF can claim tax benefits under the income tax act.
A HUF is eligible for those exemptions that are available to a resident Indian who is not a senior citizen. It can own property and also have its own business.

Who all are included in the HUF?

The HUF includes those persons who, by birth, acquire an interest in some joint family property. It also includes all lineal descendants of these persons, and their wives, and children, both sons and daughters. Even married daughters can remain a part of the HUF, while being a member of her spouse’s family HUF.

How to form a HUF?

The following steps are required to form a HUF:
(i) Open a bank account in the name of Hindu Undivided family titled “Ramesh HUF” with a rubber stamp, ID Proof, residence proof and the proof of the members of the family of HUF.
(ii) The rubber stamp should be rectangular carrying the name of the HUF and that of the Karta
(iii) Then apply for PAN (Permanent Account Number) from the income tax authorities.
(iv) Transfer the rent income received from the ancestral property along with the excess gift amount received by the HUF members (Karta, coparceners and members)

Who should actually form a HUF?

HUF will be a good option for persons who have sufficient income and savings and who also have some ancestral property too (which could be treated as family assets for HUF). Before forming a HUF one should calculate the tax benefits clearly and then take a calculated decision. 

HUF and Hindu Coparcenary

A joint or undivided Hindu family consists of male members, their wives, unmarried daughters and widows, if any, of the deceased male members of the family. A Hindu coparcenary is a smaller body than the HUF as it can only consist of male members of the family who are entitled to or acquire a right to, by birth, an interest in the joint or coparcenary property. These are the sons, grandsons and great-grandsons of the holder of the joint property, that is, the three generations in lineal male descent from the holder. The senior most member is called the Karta (Manager), who generally manages the joint or coparcenary property, belonging to all coparceners. . A HUF should consist of at least two male members but in the event of a partition of the HUF, the smaller family can form a HUF even with a single male member if it receives a portion of the property.

What are the tax benefits of HUF?

HUF is a good tax saving tool as it is regarded as a separate legal entity under the tax law and also assessed to tax separately as a distinct legal person. This implies that a person can file two income tax returns, one in his personal individual capacity and one in the name of his HUF. This gives the benefits of dividing his taxable income between two entities and hence, he can claim double deductions and expenses in both capacities, thereby reducing his total taxable income and tax liability substantially. For e.g. at present, the tax free income is Rs. 200,000 per annum.

 An individual can thus claim a minimum of Rs. 400,000 as total exempt tax free income, (Rs. 200,000 in his personal and an equal amount in his HUF return). In addition to the basic exemption, he can claim other specific exemptions in both capacities provided under sections 80CCA, 80CCB, 80D, 80DD, 80DDB, 80G, 80GG, 80 GGA and the rebate under section 88. A HUF also enjoys exemptions under sections 54 and 54F in respect of capital gains.

Income of HUF and Karta

All income arising out of utilisation HUF’s properties and from investment of HUF’s funds is income of the HUF and is separately assessed in its hands. One should be careful to declare only that income to tax in the returns of a HUF which is earned out of the HUF assets or investments. Any income, which arises out of personal income of a member will be regarded as the member’s individual income and not the income of HUF.A HUF can also contribute funds or capital in a partnership firm and the share in profits arising to the HUF will be regarded as income of HUF and will be taxed accordingly in the hands of the Karta or the representative of the HUF. Therefore, a Karta can be taxed in two capacities, his personal individual capacity and as Karta, for and on behalf of the HUF. If the partnership firm gives a certain sum as salary to the Karta or manager for the services rendered by him to the HUF, such income is taxed in the hands of the Karta in his individual capacity. Since a HUF is a separate legal entity, it can earn income from several sources such as income from house property, profits from business, income from capital gains, and income from other sources. However, a HUF cannot earn income from salaries as salary is earned for personal skills and services rendered by an individual.

Effective tax planning through HUF :

An important benefit of creation of HUF is that any income earned by an individual in his capacity as member of HUF is not taxable in his individual capacity as it is already taxed in the hands of the HUF. A HUF, being eligible for all the exemptions and deductions as are available to an individual, it results in considerable tax savings as the total personal income of an individual, who is a member of a HUF is divided into his personal capacity and in the hands of the HUF. Joint assets or properties under inheritance for the entire family can be gifted to the HUF instead of gifting to individual members of the family. This can result in tax savings as there is no gift tax or inheritance tax and clubbing of income provisions will also not apply. Similarly, a Karta of a HUF can give, by way of gifts, certain amounts or assets out of HUF properties, to its members over a period of time to gradually build assets in their names. A HUF can also build its capital by way of borrowings from non-members and the income so earned from investments of the capital will only be HUF income. Individual members may also transfer their personal funds in a HUF for the purpose of investment in tax free instruments. Income thus earned from these instruments will be tax free and cannot be clubbed with the individual’s personal income. Such income, if it is reinvested in instruments, income of which is subject to tax, will also not be clubbed as only the income earned from transferred amounts is clubbed.