In India there is the unique concept of Hindu Undivided Family (HUF) which is used by many families as a concept of common wealth pooling of the family. Interestingly, a HUF is deemed to come into existence the moment a man and woman marry each other. However, to be legally tenable, the HUF will have to be registered under the law of the land. Why are HUFs popular in India? The HUF will be treated as a separate entity so effectively you get an extra PAN card in the name of the HUF. This enables you to reduce your tax liability by splitting the incomes to an extra judicial person. Let us understand the concept of HUF and how to generate income in HUF. Let us also look at HUF advantages and disadvantages as well as how can HUF save tax for you.
What exactly is the idea behind of HUF?
HUF is basically all about treating your family as a separate unit. Assets are pooled into the common unit to form the HUF. The advantage of an HUF is that it has a separate PAN card and can also file tax returns separately. The HUF can not only be formed by a Hindu family, but Buddhists, Jains and Sikhs can also come together to form a HUF. Since the HUF has a separate PAN and also files returns separately, the HUF can also take life insurance in the names of its members and then claim deduction under Section 80C of the Income Tax Act on the premium amount paid. An HUF can also pay salaries to its members and claim such payouts as deductions. HUF is also authorized to hold investments in its name and also derive income from the same. HUF is taxed at the same rate as an individual.
How is an HUF formed and operated?
Firstly, an HUF can only be formed by a family and not by an individual. As stated earlier, an HUF automatically comes into existence when a person gets married. HUF basically consists of descendants of common ancestors, their wives and unmarried daughters. Once an HUF is formed it must be legally registered in its name. The HUF normally bears the nomenclature of the KARTAàHUF. The formation of the HUF must be supported by a legal deed. Apart from a separate PAN Account, the HUF must also have a separate bank account dedicated to it.
How does the tax benefit of HUF make a difference?
To understand the concept of tax benefits of HUF, let us consider the case of Rakesh Sharma who inherited a property from his father. This is a residential cum commercial property which is generating regular income. Post the death of his father, the income will accrue to Rakesh and will be treated as income in his hands and taxed. He can however, save his tax liability by creating an HUF and transferring the property into the HUF name. Here is how the tax advantage will work in case of Rakesh
ParticularsRakesh’s Income before HUF is formedRakesh’s Income after HUF is formedIncome of the HUFSalary Income?25,00,000?25,00,000
Interest on property deposit?6,00,000
?6,00,000Standard deduction on property?2,00,000
?2,00,000Rental income from property?5,00,000
?5,00,000Total Taxable Income?38,00,000?25,00,000?13,00,000Section 80C Exemption?1,50,000?1,50,000?1,50,000Net Taxable Income?36,50,000?23,50,000?11,50,000Tax Payable?9,34,725?5,33,025?1,62,225
Total Tax – ?6,95,250
As can be seen from the above calculation; by splitting the income between the individual and the HUF, the annual tax liability of Rakesh reduces by ?2,39,475. This tax advantage arises due to two reasons:
In the post-HUF scenario, Rakesh gets the benefit of Section 80C twice. This helps in reducing his tax returns further.
Because the income gets split, the HUF goes into the lower tax bracket and that works out more economical in tax terms.
Some challenges in the HUF structure
While the HUF structure is certainly tax efficient, there are certain challenges that you may have to face. Firstly, the moment the HUF is formed all members have equal rights in the HUF property. Since admittance to HUF is by birth, the numbers keep on increasing continuously. Secondly, in the event of the partition of an HUF, the partitioned amount paid out by the HUF will be treated as income in the hands of the individual during that financial year. Quite often, HUF partitions can become quite messy and get entangled in legal disputes.
The HUF as a concept is gradually losing its relevance with the rise of nuclear families. However, it still remains a powerful tool to save your tax outflow.