Hindu Undivided Family (HUF) is adistinct legal entity and consists of individuals who have lineally descendedfrom a common ancestor, including their wives and children. Let us see how aHUF is formed and what are its various tax benefits.
The government has made it progressively harder to create newHUFs. Therefore it is better to consult an expert while creating one. While I am personally opposed to the idea of a community-based taxrule, this blog is for those interested. It is my hope that we shalltransition to a UniformCivil Code sometime in the future getting rid of community-based rules.
A HUF consists of a Karta (a senior-most member of thefamily), co-parceners (allmembers of the family, including daughters with effect from 09.09.2005 when TheHindu Succession (Amendment) Act, 2005 came into operation) and members(females coming into the family after marriage & adopted children). The Hon’ble Delhi High Court ruled in favour ofa woman being the Karta of a HUF in Jan 2016. So women can also become a Karta.
Members of a HUF are not entitled to ask for partition (right reserved forKarta & co-parceners) but are entitled to maintenance and proportionateshare in the joint assets as and when partition takes place. You can form a HUFif you are a Hindu or a Sikh or a Buddhist or a Jain. Although the namesuggests a joint family as the essence of the HUF entity, it can also beformed by a married couple in a nuclear family unit.
HUFcan be formed by two individuals at least one of whom should be a male memberof the family. Since the HUF is taxed separately from its members, it can beused to reduce your tax outflow very efficiently. In the blog below, we willbe using the terms ‘Members’ and ‘Co-parceners’ interchangeably since there ispractically no difference between the two except for the right to call forpartition. Let us see how a HUF is formed and what are its various taxbenefits.
How to form a HUF
A HUF is automatically created at the time of marriage i.e. the start of anew family. However, to take benefit of the HUF structure, it needs to beregistered via a legal deed containing details of its members &co-parceners.
Receipt of fund from the parents or in-laws to start the operation of HUFhas to be included in the legal deed. The deed is a declaration to be signed bythe Karta with relevant details on a stamp paper which needs to be notarized.
Thereafter, a PAN is to be obtained in the name of the HUF and a bankaccount can also be opened in its name. The Karta of the HUF has the power tosign on all documents on behalf of the HUF. However, he may delegate suchpowers to other adult members of the HUF too.
A HUF is required to have some assets or property which can be provided forin different ways. This includes ancestral property, assets/property receivedthrough will and assets that come from a gift. A HUF can also have assets orproperty contributed to the HUF by its members.
Ancestral property may be defined as the property which a man inherits fromany of his three immediate male ancestors, i.e. his father, grandfather andgreat grandfather. Ancestral property & property received through a willare tax exempt in the hands of the HUF.
Although any gift received by the HUF from its members is non-taxable as perSection 56 of the Income Tax Act, 1961, the income accruing to the HUF fromsuch a gift will be clubbed with the income of the member making the gift asper provisions of Section 64 of the Income Tax Act, 1961.
Thus, transfer ofpersonal assets of the members to the HUF is best avoided.
As a workaround, the HUF can invest such sums into taxfree bonds. Sincethere is no tax on interests from such bonds, there is no clubbing of incomeinvolved. The interest of tax-free bonds can in future be invested by the HUFfree from the clubbing provision.
If there is no ancestral property, a HUF can be easily started by receivingsome gift in its name from your relatives or friends. This may be in the formof cash or assets. The gift received from close relatives is tax-free. As perthe Income-tax Act, close relatives consist of the spouse, brother and sisterof self and spouse, brother or sister of parents or parents in law, any linealascendant or descendant of self or spouse and spouse of any of the relativesmentioned here.
A gift from any other person is tax-free only up to Rs 50,000/- in a year.The income arising from such gifts or property will be the income of the HUFand will be taxed separately. The HUF can also give and receive loans from itsmembers.
Various tax benefits of a HUF
Since a HUF is a separate entity for taxation purposes and is taxed at thesame rate as individuals, it enjoys all the available deductions and exemptionsthat can be used to offset the tax payments on its income. Therefore, it can beused to reduce tax outgo through the division of income between multipleassessable units. Some of the advantages are listed below:
1. An income of up to Rs 2,50,000/- earned by the HUF is tax-free as perthe tax slabs for the Assessment Year 2020-21.
2. A HUF can be used to carry out any business separate from its individualmembers and thus, can be used to offset the tax liability which would arise inthe case of a single joint business.
3. Deductions under Section 80C can be claimed by the HUF. For example, aHUF can take insurance policy in the name of its members and make payments ofthe insurance premium which can be claimed under Section 80C. A HUF can alsocontribute to the PPF accounts of its members and claim the contribution as adeduction under Section 80C. A HUF can also openfive-year duration tax saver Fixed Deposits with banks or invest in EquityLinked Saving Schemes (ELSS) and can claim the investment as a deduction underSection 80C.
4. Under Section 80D, the HUF can also claim a tax deduction of the healthinsurance premium paid for health insurance policy taken in the name of itsmembers. Section 80DD deductions for maintenance of HUF member(s) withdisability and Section 80DDB deductions for payments on medical treatment ofspecified diseases are also available.
5. A HUF can also claim deductions on donations made to various charitableorganizations under Section 80G.
6. A HUF can make investments from its income in any instrument and theincome arising from such investments will be taxable in the hands of the HUFalong with all the concerned taxation benefits. For example, if a HUF makesLong Term Capital Gains (LTCG) of up to Rs 1,00,000/- on its equity investmentsin a year, the said income will be exempt from tax.
7. A HUF can pay a salary to its members for contributing to thefunctioning of the HUF which can be claimed as a deductible expense fromits income. However, there must be some justifiable contribution to the salaryearning members to the working of the HUF & management of its affairs.
8. A HUF can also claim deduction on interest paid on house property of upto Rs. 2,00,000/- in a year. However, the house property must be in the name ofthe HUF or jointly in the name of the HUF and one of its members. The principalrepayments can be claimed as deduction under Section 80C. The house propertycan either be self-occupied or rented out. The rental income from a rented-outproperty in the name of the HUF is taxed only in the hands of the HUF andtherefore, can be used to reduce the tax liability against a situation wherethe house property is in the name of an individual member.
9. If a member of the HUF receives House Rent Allowance (HRA) from his/heremployer and resides in the joint property owned by the HUF, he/she can payrent to the HUF and subsequently claim deduction on the HRA received.
10. Since the income after tax of the HUF is the family’s income, the Kartacan use it for family expenses and can also distribute it among the memberswithout any further tax liability.
11. The HUF can also be a non-residentif the management & control of the HUF is done from outside India.
Disadvantages of the HUF structure
The main disadvantages of a HUF arise from the joint ownership of assetsunder the HUF structure. Any asset which becomes part of the HUF is a commonasset and the previous owner (who could be a member or a relative who giftedthe asset) relinquishes all ownership rights over the asset. Thus, all assetsof the HUF are family assets and no specific member has ownership over them. Inthe present times, disillusionment with the joint family structure isincreasing and in such cases, it can be very difficult to get out of the HUFwith any asset in your own name. Only when all the members of the HUF are inagreement can a property be shared among the members. Similarly, shutting downa HUF may also turn out to be a pain point since the consent of allco-parceners of the HUF is required to do so and requires a partition of theHUF’s assets. This can lead to legal disputes and general ill-will among thefamily members.
Some other disadvantages of HUFs are:
1. Since every addition of a person by marriage or birth to the family results in an addition to the HUF, the HUF structure can become unwieldy and too complex after a while.
2. The HUF continues to be assessed until its partition. Thus, once an income tax return is filed for the HUF, you have to continue filing the returns till the HUF is dissolved/partitioned, even if there is no income. Any claim for partition is also made to the assessing officer.
3. A HUF is required to file its income tax returns separately which means a separate set of tax calculations and form filing, including an audit of accounts as per its turnover. However, this is a natural accompaniment to the tax savings.
4. In a peculiar case, an adopted child can only become a member of the HUF and not a co-parcener i.e. he/she cannot ask for partition of the HUF.
5. The state of Kerala does not recognize HUFs. So if members of a HUF purchase property in Kerala then it will not be considered as part of the HUF.
6. The members of the HUF are liable to the clubbing provisions in the Income Tax Act if they transfer an asset to the HUF without appropriate consideration.
HUFis an attractive vehicle for tax saving available to most taxpayers. Theprocess for starting it is also straight forward and does not require much timeor resources. However, the HUF structure also brings with it the concept ofjoint ownership of assets and equal rights over them. Thus, it may becomedifficult to manage and partition in case of a large family with competingviewpoints of the HUF members. Therefore, it is very important to carefullyweigh the pros and cons of the HUF structure with a view towards futurecomplications and not jump in for the tax savings alone.
