What is a HUF?
HUF stands for Hindu Undivided Family. To reduce taxes, you can establish a family group by combining assets to create a HUF. The HUF is subject to taxation separately, distinct from its members. Not only Hindu families but also Buddhist, Jain, and Sikh families can create an HUF. A HUF obtains its unique PAN (Permanent Account Number) and submits tax returns independently of its members.
Tax implications of forming a HUF
How to save tax by forming an HUF?
A HUF is subject to taxation independently of its members, which enables it to apply for deductions or exemptions provided by tax regulations individually. For instance, if you and your spouse, along with your two children, establish a HUF, all four of you, as well as the HUF itself, can seek a deduction under Section 80C. Typically, families use HUF as a strategy to accumulate assets. Let’s delve deeper into this concept.
How is HUF taxed?
- The Hindu Undivided Family (HUF) possesses its unique PAN (Permanent Account Number) and submits a separate tax return. It operates as a distinct entity apart from its members.
- Within its income tax return, the HUF can claim deductions under Section 80 and avail of other exemptions.
- Additionally, the HUF can acquire life insurance policies for its members and provide salaries to those who contribute to its functioning. These expenses will be deducted from the HUF’s income.
- Investments can be made using the HUF’s income, and any returns from these investments are subject to taxation within the HUF.
- It’s worth noting that the HUF is taxed at the same rates as an individual.
Let’s explore how HUF taxation works with an example:
Following the passing of his father, Mr Rajesh Chopra chose to establish an HUF with his wife, son, and daughter as its members. Since Mr. Chopra has no siblings, his father’s property is transferred to the HUF’s ownership.
This property generates an annual rental income of Rs 7.5 lakhs. Mr. Rajesh Chopra also earns a salary income of Rs 20 lakhs. The creation of the HUF allows Mr Chopra to achieve tax savings, as explained below.
Income from various sources | Individual’s Return | HUF’s Return | |
Income of Mr. Chopra before formation of HUF | Income of Mr. Chopra after formation of HUF | Income of HUF | |
Salary | 20,00,000 | 20,00,000 | |
House property rent | 7,50,000 | – | 7,50,000 |
Standard deduction on house property | (2,25,000) | – | (2,25,000) |
Income from house property | 5,25,000 | – | 5,25,000 |
Total taxable income | 25,25,000 | 20,00,000 | 5,25,000 |
Section 80C | (1,50,000) | (1,50,000) | (1,50,000) |
Total tax paid by Mr. Chopra | 5,53,625 |
Total tax paid by Mr. Chopra & HUF | (3,99,125) |
Tax saving due to forming an HUF | 1,54,500 |
Thanks to this tax strategy, Mr. Chopra was able to reduce his tax liability by Rs 1,54,500. Both the HUF and Mr Chopra (along with other HUF members) can benefit from a deduction under section 80C. Additionally, any income earned by the HUF can be invested by the HUF itself and will remain subject to taxation within the HUF.
How to form an HUF?
Although there are tax benefits associated with creating an HUF, certain conditions must be met –
Formation of an HUF comes with specific conditions:
- HUF formation requires a family, not an individual.
- Marriage automatically triggers the creation of an HUF.
- HUF includes a common ancestor and all of their direct descendants, along with their wives and unmarried daughters.
- Hindus, Buddhists, Jains, and Sikhs are eligible to establish HUFs.
- HUF typically accumulates assets through gifts, wills, ancestral property, sales of joint family property, or contributions from HUF members.
- After its formation, HUF must be officially registered in its name, usually through a legal deed. This deed should outline HUF members and the HUF’s business activities. Additionally, a PAN number and a bank account should be opened under the HUF’s name.
The disadvantage of forming a HUF
While HUF may appear as an ideal means to achieve tax savings as a family, it does have its disadvantages.
Opening an HUF does have certain drawbacks, which include:
Equal Rights of Members: One significant disadvantage is that HUF members all have equal rights to property. This means that property cannot be sold without the agreement of all members. Additionally, any new family members, whether through birth or marriage, become part of the HUF and gain equal rights. As a result, HUFs can become quite large and challenging to manage.
Partition: Dissolving an HUF can be a complex and challenging process. The only way to dissolve it is through a partition, which requires unanimous agreement from all members. During a partition, assets are divided among members, potentially leading to disputes and legal complications.
Relevance of Joint Family System: The concept of HUF was designed for joint family systems, but in today’s world, nuclear families are more common. As a result, HUFs are losing relevance, and disputes over common household expenses and asset pooling have become more prevalent, especially with rising divorce rates.
Continued Assessment: Once you establish a HUF, you are obligated to file its tax returns unless a partition occurs. To claim a partition, you must approach the assessing officer, who will conduct an inquiry after notifying all members. The income from the partitioned property is then taxed as individual income for the members. If a member creates a new HUF with their spouse and children, the income from the property transferred from the original HUF is taxed within the new HUF.
In summary, while HUFs offer tax benefits, they also come with challenges related to property rights, dissolution, changing family dynamics, and continued tax assessment until a partition is initiated.
FAQs
1. What is an HUF, and who can form it?
A HUF, or Hindu Undivided Family, is a legal entity recognized under Indian tax law. Hindus, Buddhists, Jains, and Sikhs can form it. It consists of a common ancestor and all of their lineal descendants, including their wives and unmarried daughters.
2. How does taxation work for HUFs?
HUFs are taxed separately from their members. They have their PAN (Permanent Account Number) and file independent tax returns. HUFs can claim deductions and exemptions just like individuals.
3. Can an HUF own and manage assets?
Yes, HUFs can own and manage various assets, including property, investments, and businesses. The income generated from these assets is considered HUF income and is taxed accordingly.
4. What are the advantages of forming a HUF for tax planning?
Forming a HUF offers several tax benefits, such as additional deductions under Section 80C, tax exemptions, and the ability to split income among family members, potentially reducing the overall tax liability.
5. Are there any disadvantages or limitations to having a HUF?
Yes, there are drawbacks to HUFs, including the equal rights of members over property, the complexities of partitioning the HUF, and the decreasing relevance of joint family systems in modern times.
It’s important to consider these factors when forming an HUF.
These FAQs and answers provide a basic understanding of HUFs and their implications for tax planning. Readers seeking more detailed information should consult with a qualified financial advisor or tax consultant.
