10 Tax Benefits of Forming a 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 the income of a HUF taxed?
In order to compute the income of an HUF, one has to first ascertain its income under the different heads of income (ignoring incomes exempted under sections 10 to 13A of the Act). The following points should be kept in mind while computing income:
- If funds of an HUF are invested in a company or a firm, fees or remuneration received by the member as a director or a partner in the company or firm may be treated as income of the family (if fees or remuneration is earned essentially as a result of investment of funds).
- However, if fees or remuneration is earned for services rendered by the member in his personal capacity, it will be treated as the personal income of the member.
- If any remuneration is paid by the HUF to the karta or any other member for services rendered by him, remuneration is deductible from income of HUF if such payment is genuine and not excessive and paid under a valid and bona fide agreement.
The following incomes are not taxed as income of HUF:
- If a member has converted or transferred without adequate consideration his self-acquired property into join family property, income from such property is not taxable in hands of the family.
- Income of impartible estate (though it belongs to family) is taxable in the hands of holder of estate and not in hands of HUF.
- Personal income of the members cannot be treated as income of HUF.
- “Stridhan” is absolute property of a woman, hence income arising therefrom is not taxable as income of HUF.
- Income from individual property of daughter is not taxable in hands of HUF even if such property is vested into HUF by daughter.
A HUF is taxed separately from its members, therefore, deductions (such as under Section 80) or exemptions allowed under the tax laws can be claimed by it separately. For example, if you and your spouse along with your 2 children decide to create a HUF, all 4 of you as well as the HUF can claim a deduction for Section 80C. HUF is usually used by families as a means to build assets.
Here are 10 benefits of forming an HUF:
1) 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.
2) 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.
3) 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.
4) 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.
5) 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.
For instance, Mr A earns Rs 9 lakh per year and has an ancestral property, which yields Rs 3 lakh as annual rent. If A got the property from his father, while calculating his tax liability, both incomes will be clubbed and taxed in his hands.
Assuming that A has no investments and not considering education cess, rebate and surcharge, he will be subject to a tax of Rs 1,72,500 (30% slab for FY 2020-21).
If the property is transferred to an HUF of which A is the Karta, then under the same assumptions, A will pay Rs 92,500 (20% slab for FY 2020-21) as individual tax and the HUF will pay Rs 2500 (5% slab for FY 2020-21) as tax. So, in all there will be a tax saving of Rs 77,500. The rent becomes tax-free in the hands of the Karta and for the other members as well.
6) 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.
7) HUF can settle on a tax saving arrangement at the time of partition
If an HUF comprises of a Karta (father) and four adult sons and they have two business units, a house and other miscellaneous income sources. If the HUF members are not earning, then partition can be done by giving each enterprise to two sons so that partition is impartial. This will significantly bring down tax liability.
8) There is no requirement for nucleus or ancestral joint family assets for the HUF to exist
All the members in your family, including your wife, children, their wives and their children. While the male members are called coparceners, the females are referred to as members. The senior-most male member is called the karta (manager), and a typical HUF consists of a karta, his sons, grandsons, and great-grandsons (all of whom are coparceners), and their wives and unmarried daughters (all of whom are members).
An HUF comes into existence the moment you give birth to a son (or a daughter, if she is regarded as a coparcener in the state where most of your property is located). There is no requirement of holding an ancestral property or family asset while forming a HUF.
9) Official stature of an HUF remains the same even in the hands of women in the event of the demise of Karta or the last male member in the family
A Hindu widow being the sole surviving member, cannot constitute a HUF was the decision in Gangamma Vs. Agl. ITO (1991) (Ker.). After the Amendment in the Hindu Succession Act, in 2005, a Hindu Widow and her unmarried daughter can constitute a HUF, even when the widow had not adopted a son since, daughter is also a coparcener.
10) Members of HUF can easily avail loans
An HUF consists of Karta and Co-parceners. Members under HUF’s generally have more chances of availing bank loan than they would have on an individual basis.
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.