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November 1, 2020

How to form a small HUF within a bigger HUF?

by CA Shivam Jaiswal in Income Tax

How to form a small HUF within a bigger HUF?

Under Hindu Law, a Hindu Undivided Family (HUF) is a family which consists of all persons lineally descended from a common ancestor, and also the wives and daughters of the male descendants. It consists of the Karta, who is typically the eldest person or head of the family, while other family members are coparceners. The Karta manages the day-to-day affairs of the HUF. Children are coparceners of their father’s HUF.

How is a HUF covered under Income Tax Provisions?

Under section 2(31) of the Income-tax Act, 1961, an HUF is considered a “person” and, therefore, is treated as a separate entity for the purpose of tax assessment. Often families that own ancestral properties and businesses obtain a separate Permanent Account Number (PAN) in the name of the HUF. This is done so that the incomes earned from the assets and businesses owned by the HUF are assessed separately, which also brings down the family’s tax liability. An HUF is taxed on the same slab rates that are applicable to an individual income tax assessee.

How is a HUF formed?

A HUF automatically comes into existence when a person gets married and starts his family. It is not necessary that this new family should also have kids. Although a HUF is automatically formed at the time of marriage, it is always advisable to have a written agreement as the Banks and Income Tax Department asks for a HUF Deed. It is not necessary that HUF is created on the day of marriage itself and can be created at any point of time in future.

To create a HUF, the below mentioned steps are required to be followed:

Step 1 – Create HUF Deed

  • The HUF Deed is a written formal document on a Stamp Paper stating the names of the Karta and the Co-parceners (Members) of the HUF. The eldest male member of the HUF becomes the Karta of the HUF.
  • A declaration is also provided by each member of the family where they declare the name of Karta and also state that:
    • The Karta has the authority of the accounts vested in his hand
    • The members are the only members of the HUF
    • The Karta holds the right to govern all the transactions of the HUF accounts on behalf of the members.
  • The names of the members of the HUF and the name of the HUF are also required to be stated in the HUF Deed at the time of creation of HUF.
  • It also states the capital with which the HUF has been initiated. There are various sources through which Capital can be introduced in the HUF.

Step 2 – Apply for HUF PAN Card

The HUF will be treated as a separate entity so effectively you get an extra PAN card in the name of the HUF and file the income tax returns separately. This enables you to reduce your tax liability by splitting the incomes to an extra judicial person and also claiming deductions separately.

An application for HUF PAN Card is required to be made in Form 49A which can be furnished online as well as manually. HUF PAN Card Application can be made online through this link: https://tin.tin.nsdl.com/pan/form49A.html

The application for PAN Card and the Income Tax Return would be signed by the Karta.

Step 3 – Open separate HUF Bank Account

  • A HUF is also required to open a Bank Account in which it will receive all payments.
  • A HUF Account can be opened in any bank account.
  • At the time of opening of HUF Bank Account for creation of HUF, all documents pertaining of the HUF should be properly stamped. This rubber stamp should be rectangular as Round Stamps are now not accepted.

What do you mean by a bigger and a smaller HUF?

Generally, the term Bigger HUF and Smaller HUF is used in the matters relating to Joint family Property.

Bigger HUF generally refers to the HUF consisting of all the members of Joint Hindu Family and the Smaller HUF refers to a branch of the such family which is carved out of the bigger HUF and which holds property which is ancestral in the hands of that branch only and which is separately identifiable to that branch and the members of that branch only.

A son can have smaller HUF with his wife and children, while he continues to be a member of his father’s HUF. In his father’s HUF, he is mere a member, and his own, he is a Karta.

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In the case of CIT vs M. M. Khanna(1963), the Bombay High Court held that:

  • It must be remembered that a joint Hindu family springs from a Hindu male and every Hindu male can be the stock of a fresh descent constituting a joint Hindu family a joint Hindu family or a Hindu coparcenary.
  • Where from a Hindu male a joint Hindu family springs into existence, this family goes on having its different branches and sub-branches.
  • Each branch starts with the male descendant of the common ancestor and each sub-branch with the male descendant of the head of the branch.
  • While the entire group proceeding from the common ancestor with its several branches and sub-branches in the normal undivided state is a Hindu joint family, each of the branches of each of the sub-branches again is a Hindu joint family according to the concept of a joint family under the Hindu law.
  • It is, therefore, possible for a main Hindu undivided family to be composed of a large number of branch families, property may be possessed by the entire family in which members of the family have interest by birth.
  • Individual members of the family again may possess property, which belongs to them separately as distinct from the joint family of which they are members.
  • Where a Hindu joint family consists of branch families it may also be that each of the branch families may possess property which constitutes the joint family property of that branch alone and in which the other branches or the main Hindu family as such have no right or interest.

Thus, the Bigger HUF and the Smaller HUF can simultaneously function without any hindrance and simultaneously be assessed to the Income-tax.

Will Co-parceners of a Smaller HUF continue to remain Co-parceners of the Bigger HUF?

  • Co-parceners of an HUF will continue as co-parceners until the HUF is partitioned or until the co-parcener releases all his/her undivided right, interest and share in the HUF in favour of the other co-parceners under a duly executed deed of Release.
  • Co-parceners of an HUF will continue as co-parceners, unless the co-parcener marries a non-Hindu under the provisions of the Special Marriage Act, 1954, in which case there is a deemed severance by such co-parcener from the HUF (Section 19 read with Section 21A of the Special Marriage Act, 1954).

Here are some benefits of forming a smaller HUF:

Forming an HUF can provide you with an extra PAN – The HUF will be treated as a separate entity so effectively you get an extra PAN card in the name of the HUF and file the income tax returns separately. This enables you to reduce your tax liability by splitting the incomes to an extra judicial person and also claiming deductions separately.

Help Claim Life Insurance Deductions separately – Provisions of the Income Tax Act allow individuals to claim tax benefits on certain payments they make during a year. Similar benefits are applicable for an HUF. For example, an HUF can pay Life Insurance premium for individual members, and claim tax benefits under Section 80C. The maximum amount that can be claimed as a deduction under this section is Rs 1.5 lakh.

HUF hold investments in their own name – An HUF is allowed to make investments in tax-saving Fixed Deposits and Equity Linked Savings Scheme (ELSS) to earn tax benefits of up to Rs 1.5 lakh under Section 80C. And while an HUF cannot open a Public Provident Fund (PPF) in its name, it can claim tax deductions for the amount deposited by the HUF in respective PPF accounts of its members.

Help Claim Health Insurance Deductions

  • Every individual or HUF can claim a deduction under Section 80D for their medical insurance which is taken from their total income in any given year. Not only can an individual take benefit by purchasing a health plan for themselves but also one can take advantage of buying the policy to cover their spouse, dependent children or parent. 
  • HUF’s are also eligible to claim deductions under this section. The premium payments of any member in a HUF can be used for tax deductions, which is however, subject to upper limit as per the Act.
  • You can claim a deduction of Rs 25,000 per year on premiums paid for Health Insurance for your family under Section 80D. However, with the rise in Health Insurance premiums, this limit can be insufficient when you want to provide decent health coverage for your family.
  • Here’s where HUF can come to your rescue. You can claim additional tax benefit of up to Rs 25,000 on Health Insurance premiums paid during the year for family members of the HUF. If the person is a senior citizen, the limit goes up to Rs 50,000.

Transfer of Property can help in saving tax  -HUF’s or members of HUF’s generally own an ancestral property that yields rental income. Under normal circumstances, the rent will be attached to a person’s income and will be taxed according to that individual’s tax slab. However, if it is transferred to an HUF, the income will be that of the HUF’s and will be taxed separately.

Forming an HUF can help avoid Tax Audit

Tax Audit refers to the independent verification of the books of accounts of the assessee to form an opinion on the matters related to taxation compliances carried out by the assessee.

Every person who derives income by way of Business or profession and maintains books of accounts and has not opted for computation of income on presumptive basis under section 44AD, 44ADA or 44AE of the Income-tax Act, 1961 has to get tax audit done provided his income exceeds the prescribed threshold limit of:

  • A person carrying on business if the total sales/ turnover exceeds Rs 1 crore during the previous year.
  • A person carrying on profession if the Gross receipts exceed Rs 50 lakhs during the previous year.

However, if the income of an individual is divided with the help of an HUF, the total sales/ turnover or gross receipts will get eventually reduced, thus avoiding the scenario of conducting tax audit.

In conclusion, upon the marriage of a male co-parcener, his wife also becomes a member of the HUF (though the wife of a co-parcener is not a co-parcener but is a member of the HUF). The children of a co-parcener automatically become co-parceners at birth. Under Hindu law, there can be an HUF within an HUF. Therefore, a son can establish his own independent HUF (with his wife and children and further lineal descendants) while he continues to be a member of his father’s HUF.

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