Taxpayers like you and me go to great lengths to try and save on taxes. We try and invest in various tax saving instruments, without analysing whether these instruments help us meet our financial goals or not. Sometimes, we end up investing in schemes after reading good reviews about it in reputed magazines, newspapers, television etc. without doing our own due diligence.
Sometimes, Individuals also resort to dubious activities to save tax on their income, and in this process they may become tax evaders, which is illegal as per our Law. However, our Tax Provisions provide sufficient scope for Tax Planning. There are several provisions in Income tax law, which can help you save tax through proper planning and execution.
HUF or Hindu Undivided Family is one such avenue which can help you save tax. I remember clearly during my CA articleship days how Gujarati families used to open their HUF accounts through my CA firm as soon as they get married. At that time, I used to wonder whether it is such an efficient means of tax saving by forming HUF.
Let’s have a look at this a relatively unknown tax saving tool.
What is an HUF?
The term HUF stands for ‘Hindu Undivided Family’ and comprises of all descendants of a common male ancestor and includes their wives and unmarried daughters. The term of HUF is not defined in income tax law; it is defined under the Hindu Law as a family.
The family continues to exist even after the death of the common ancestor and the next eldest male member becomes the head of the family or the “Karta”. In financial terms, we can call him ‘manager of the family’. Even on the death of all the male members, the HUF continues to exist.
What is so special of an HUF?
Under the tax laws in India, an HUF is treated as an independent person (Separate legal entity) for tax purposes and also assessed to tax separately as a distinct legal person. It means, like you and I, it is a taxable entity and is subject to tax provisions in India. Therefore, like an individual taxpayer, it has all the benefit of Income Tax Slabs, Deductions u/s 80 and the majority of the tax provisions including exemptions which are otherwise available to Individuals.
So, if an individual is able to structure his taxable income or split his taxable income between his Individual self and his HUF, he can claim double benefits for deductions and expenses in both capacities, thereby substantially reducing his overall tax liability. An individual can file two income tax returns, one in his individual capacity and second in the name of his HUF.
How is an HUF formed?
The term ‘Hindu Undivided Family’ (HUF) is defined under Hindu Law, so it can’t be created by an agreement between two parties, nor can it be formed by group of people who do not constitute the family. Membership to an HUF comes from the status of the person in such family and so to be a part of an HUF, you must have lineally descended from a common Male ancestor.
HUF also gets created immediately upon the marriage of an Individual. In such a situation, the HUF will comprise of two members, the individual and his spouse. On the birth of any child, the HUF will also include the child as a member. Any individual who is born Hindu, Sikh, Jain or Buddhist can form an HUF, provided he is married. All lineal descendants of the Karta, their spouses and children automatically become members of his family. However all the family member do not require to live under the same roof, they can continue to live separately.
What are the benefits of using HUF from an Income Tax perspective?
Since an Individual and an HUF has similar benefits under the Income Tax Act, 1961, if a married individual can shift his income legally to his HUF, then he will have the benefit of much lower tax liability.
Similarly, several individuals are not able to utilise the exemptions and deductions available to them under provisions of Income Tax Act, 1961. For e.g. Section 80 C, 80 G, 80 D etc. Because of the sub-limits imposed on such deductions. For e.g. Maximum Deduction u/s 80 C is restricted to Rs. 1,50,000/-. Such individuals can route these payments through their HUF and thereby avail the benefit of deductions under these sections through their HUF.
Let’s try to understand this better with the help of an Example.
Let’s take the case of Mr A, a married man having two children working in the Corporate Sector and earning a Salary of Rs. 20, 00,000/- per year. His income includes income from investments of Rs. 10, 00,000/-. He also pays Life insurance Premium of Rs 60,000/- for his family, PPF investment of Rs. 1, 00,000/-. His Company deduct PF of Rs. 1,50,000/- from his Salary. He also pays medical insurance premium for himself and his family of Rs. 20, 000/-
Let’s assume that Mr A is able to legally shift his income from investments of Rs. 10,00,000/- to his HUF. He also pays Life Insurance premium of Rs. 60,000/- and PPF of Rs. 1,00,000/- in his name from his HUF. Let’s see his revised tax outflow in this scenario.
Savings of Tax under option B= Rs 2, 11,150 per year.
(6, 94,220 – 4,83,070)
Thus, from the above example, it is evident that, if A is able to legally shift the incidence of taxable income from his individual capacity to his HUF and make payment of expenses on which he gets tax deductions from his HUF, he is able to save nearly Rs. 2,00,000/- every year.
Sounds too good to be true right! Now, in order to generate income and invest in the name of the HUF, it is important to capitalise the HUF or generate income in the hands of the HUF. How can you do that?
This step is the most important step in tax planning using the HUF route. Unless the HUF has its own capital, it will not be able to make investments thereby not generating tax efficient returns for the family. Hence, it is essential to ensure that the HUF has sufficient funds to help make investments in its own name.
Following are some of the legal ways in which an HUF can be capitalised
- Through an inheritance
If Mr A is expected to receive some inheritance through a will, he can choose to take the inheritance in the name of his HUF rather than taking the inheritance in his own name. By clearly mentioning in the will that the inheritance would belong to the HUF of Mr A, it can be ensured that the income arising from the investment is taxed in the hands of the HUF of Mr A rather than Mr A in his individual capacity.
For e.g. If the Individual in our example is expected to receive ownership of a house property which has been let out as rent in his name under a will, he can choose to receive it in the name of his HUF. That way, the rental income which is received by the HUF can be used to generate capital for HUF.
- Gifts received by HUF
Gifts can also be obtained by Mr A in the name of his HUF. In case if the amount of gifts received by Mr A in the name of his HUF is in excess of Rs. 50,000/-, it will be taxed in the hands of the HUF as Income from Other sources. However, if the gift is received from relatives, this restriction of Rs. 50,000/- also does not apply.
What are the other benefits of routing your investments through your HUF?
As mentioned earlier, the HUF is subject to the majority of the provisions which are applicable for an Individual. This would include,
- Basic exemption limit on which no tax is levied of Rs. 2,50,000/- (for Assessment Year 2016-2017)
- Deductions u/s. 80 C, 80 D, 80 CCF, 80 DD, 80DDB, 80G etc.
Hence, HUF income can be used to incur expenses of the family including all the members and thereby take advantage of double deductions u/s 80 C, 80 D, 80 CCF, 80 DD etc. It can also distribute income earned by it as gifts to its members and the same is tax-free income in the hands of the members.
It can also be used to pay insurance premium (e.g. Health and Life Insurance) of all its members, invest in mutual funds, invest in shares, debentures, National Savings Certificates, fixed deposits etc. on behalf of its members. HUF can also invest in long-term infrastructure bonds Exemptions or deductions if any enjoyed by such investments under Income Tax Act, 1961 would be available for the HUF.
What kind of paperwork is required for an HUF?
- Obtain PAN number in the name of the HUF.
- Open bank account in the name of the HUF.
- Open Demat account in the name of the HUF.
- Use the HUF’s bank account to make all investments / expenses.
- Maintain proper documentation and books of accounts to keep own investments and investments of HUF segregated.
- KARTA of the HUF will have the power to sign all the documents on behalf of the HUF.
- Filing income tax return separately for the HUF.
What are Drawbacks of an HUF?
The assets of the individual will now become the assets of the HUF as a family unit comprising of the individual and all members of the family. All members of the family would have a right on the assets unlike if the assets were owned by an individual in his own name. Therefore, proper caution should be exercised before transferring assets in the name of the HUF.
An Individual cannot transfer his assets to the HUF since the Clubbing provisions u/s 64 (2) of the Income Tax Act, 1961 would apply and the income earned from the transferred asset would continue to be taxed in the hands of the transferee.
Similarly, Partition of the HUF will have to be carefully thought through. The dissolution of an HUF will take place after the full partition of the assets of the HUF amongst its members. This may require execution of legal documentation to make it full proof.
As the maxim goes, a penny saved is a penny earned. Use of an HUF structure is an efficient and legal way to save tax, especially for high-income earners. This helps them to maximize the benefits available under the existing provisions of the Income Tax Act 1961 to plan and save tax on their income which otherwise may have been taxed at higher rates.
Word of Caution
This article merely seeks to provide you with some information on possible avenues to reduce your tax liability. The establishment of an HUF, its capitalisation, maintenance of books of accounts and records, filing tax returns, distribution of assets etc. should be managed meticulously to avoid any issues from Income Tax Authorities. Hence, please consult a Tax practitioner or a Practising Chartered Accountant for guidance before you try and use this route.
The Author is a Chartered Accountant by education and has been working in Securities Industry for more than 13 years with Stock exchanges and institutional brokerage firms. He is an avid reader and enjoys volunteering in his spare time.