HUF or Hindu Undivided Family is one of the most effective and legal ways for saving tax. The Income Tax Law provides the provision of HUF or Hindu Undivided Family by which you can save tax through proper planning and execution.
In this post, we focus on HUF and show you income tax slabs available with HUF as well as the how you can save tax legally by forming an HUF.
In India, there has been an age old tradition of undivided families. The incomes generated by such families are considered as joint income as compared to individual Incomes.
So, such incomes are not taxed in the hands of any specific individual but are taxed in the hands of the whole family. As the income is taxable in the hands of the family, the family possesses a separate PAN Card, as well as the individual HUF members, also have a separate PAN Card.
What is an HUF (Hindu Undivided Family)?
The term HUF signifies ‘Hindu Undivided Family’ and consists of all descendants of a common male ancestor including their wives and unmarried daughters. The term Hindu Undivided Family is not defined in the Income Tax Law. However, it is defined under the Hindu Law as a family.
In the case of an HUF, the family continues to exist even when the common (eldest) ancestor dies. In such cases, the next eldest male member takes over as the head of the family. He is called as ‘Karta.’ In financial terms, the ‘Karta’ can be understood as the ‘Manager of the Family.’ The HUF continues to exist even after the death of all male members.
HUF or ‘Hindu Undivided Family’ is treated as a ‘person’ under section 2(31) of the Income Tax Act 1961. It is considered as a separate entity for the purpose of assessment under the Act.
So, an HUF family consisted of all persons lineally descended from a common ancestor and included their wives and unmarried daughters. It has to be noted that an HUF cannot be created under a contract. On the contrary, it is automatically created in a Hindu Family. Although Jain and Sikh families are not governed by the Hindu Law, they are treated as HUF under the Act.
What is so special about an HUF?
As per the Income Tax Laws of India, an Hindu Undivided Family is regarded as a separate legal entity or as an independent person for tax purposes. It is assessable to tax separately as a distinct legal person.
So, an HUF is also a taxable entity and is subject to tax provisions in India. An HUF gets all the benefits like an individual taxpayer. It is eligible for all the benefits of Income Tax Slabs, Deductions u/s 80 and other tax provisions and exemptions which are otherwise available to individual taxpayers.
An HUF gives an individual the opportunity to file two income tax returns, one in his individual capacity, and the other in the name of his HUF.
So, an individual can split or structure his taxable income between the individual self and his HUF, thereby claiming double benefits regarding deductions and expenses both as an individual and for his HUF. Thus, an HUF helps to reduce his overall tax liability substantially.
How to form a HUF?
As the term, Hindu Undivided Family (HUF) is defined under Hindu Law so it cannot be created by an agreement between two parties. Nor an HUF can be formed by a group of people who do not constitute the family. To be a part of HUF, you need to be lineally descended from a common male ancestor.
An HUF also gets created immediately once a person gets married. In such cases, an Hindu Undivided Family will consist of two members that are, the individual and his spouse. When a child is born, he or she is also included as a member of the HUF.
So, any individual who is born Hindu, Sikh, Jain, or Buddhist can create an HUF. However, he should be married. All the lineal descendants of the Karta, including their spouse and children, become members of his family automatically.
However, all HUF members do not require living under the same roof. They can choose to live separately.
Benefits of HUF for Income Tax perspective
An HUF gives you the opportunity to avail benefits under the Income Tax Act, 1961. A married individual can shift some income legally to his HUF and can get the benefit of much lower tax liability. By having an HUF, one can utilize the deductions and exemptions available under provisions of Income Tax Act, 1961.
Let’s take an example so that you can understand this better.
Let’s suppose that Mr. X is a married man working in the Corporate Sector and drawing a Salary of Rs.10,00,000/- per year.
His income from other sources (rental income) amounts to Rs.5,00,000 per year. He contributes to the PPF of the amount Rs.150000. He pays a medi-claim premium of Rs.20,000.
Gross Taxable income from all sources = Rs. 15,00,000 (10,00,000 + 5,00,000)
Deductions u/s 80C = Rs.1,50,000 (PPF Contributions)
Deductions under 80D (Medical Insurance Premium) = Rs.20,000
Net Taxable Income from all Sources = Rs. 13,30,000
Tax = Rs. 2,24,000
Education Cess = Rs. 4,480
Secondary and higher education cess = Rs. 2,240
Total Tax Liability = Rs.2,30,720
Let’s assume that Mr. X legally shifts his income from other sources of Rs.5,00,000 to his HUF. Let’s calculate his revised tax outflow in this scenario.
Gross Taxable Income from Salary = Rs. 10,00,000
Deductions u/s 80 C = Rs.150000
Deductions under 80D = Rs.20,000 (Medical Insurance Premium)
Net Taxable Income from all Sources = Rs.8,30,000
Tax = Rs.91,000
Education Cess = Rs.1,820
Secondary and higher education cess = Rs.910
Total Tax Liability = Rs.93,730
Now, let’s calculate the tax liability of Mr. X’s HUF:
Gross Taxable Income from all sources = Rs.5,00,000
Income Tax = Rs.25,000
Education Cess = Rs.500
Secondary and higher education cess = Rs.250
Total Tax Liability = Rs. 25,750
Savings of Tax under Option B = 230720 – (93730 + 25750) = Rs.1,11,240
So, we see that by having an HUF account, Mr. X is able to save Rs.1,11,240/- every year.
By forming an HUF, one can pay insurance premiums of all its members, invest in shares, debentures, and mutual funds, fixed deposits, and National Savings Certificate on behalf of its members.
Paperwork required for forming an HUF?
You need to obtain PAN number in the name of the HUF.
A Bank Account needs to be opened in the name of the Hindu Undivided Family.
One can Open Demat Account/Share Trading account in the name of the HUF.
HUF’s bank account can be used to make all expenses / investments.
Maintain proper books of accounts for keeping own investments and investments of HUF segregated.
Filing income tax return separately for the HUF.
The KARTA of an HUF has the power to sign all the documents on behalf of the HUF.
Income Tax Slab for HUF
Income up to Rs. 2,50,000: No Tax
Income from Rs. 2,50,000 – Rs. 5,00,000: 5%
Income from Rs. 5,00,000 – 10,00,000: 20%
Income more than Rs. 10,00,000: 30%
Drawbacks of an HUF?
While taking the HUF route, you should take note of certain very important points. When you form an HUF, all members of your family will gain equal right on the assets disparate if the assets were owned by the individual himself. Therefore, you should exercise caution before transferring assets in the name of the HUF.
Then there are Clubbing provisions u/s 64 (2) of the Income Tax Act, 1961 that prevents an individual to transfer his assets to the HUF. The income gained from the transferred asset would be anyhow taxed in the hands of the transferee.
Similarly, dissolution of an Hindu Undivided Family can come to effect only when the assets are fully partitioned amongst the members of the HUF. It requires legal documentation to make it full proof.
An HUF structure is a highly efficient and legal way for saving tax, especially when you are a high-income earner. An Hindu Undivided Family lets you save tax on your income which otherwise would have been taxed at a higher rate. Although this article provides ample information about HUF, you must consult a Tax practitioner or an experienced practicing C.A. for guidance before you to try to use this route.