HUF - What, Why & How?

What is HUF (Hindu Undivided Family)?

HUF is a family with husband, wife and children (and children’s spouses if any) living together. The property owned by this family will be through lineal ascendants or any ancestors. There are a set of laws that govern property ownership, marriages, taxation etc for a legally declared HUF. IT department of India has a format of taxation for a HUF; tax benefits can be availed from this format

Why HUF to Save Tax?

A very effective and legal way to save tax is to form a separate tax entity HUF i.e. Hindu Undivided Family. The creation of Hindu Undivided Family helps the tax payers to save their taxes in a legal manner. In India there are many families which are undivided and the incomes earned by such families are joint income as compared to Individual Incomes.

As these are joint incomes and not Individual Incomes, these incomes cannot be taxed in the hands of any specific individual and are therefore taxed in the hands of the whole family. As these are taxed in the hands of the family, the family has a separate PAN Card as compared to Individual members of the HUF who also have a separate PAN Card.

It is a well known fact that every individual member of the family specially the adult members of the family would enjoy a tax deduction up to Rs. 1,50,000 in under section 80C of the Income-tax Act, 1961.However, most of the prudent individuals are able to take the full advantage of the said section 80C of the Income-tax Act, 1961. 

Basically the logic behind forming an HUF to save tax is to avail the benefit of an extra PAN Card legally. As the Income of the Family is not taxed in the hands of any specific Individual, a new PAN Card is allotted to the HUF and Tax would be paid by the Family using this PAN Card.

As a new PAN Card would be allotted to the whole family, it will also enjoy the benefits of Income Tax Slab Rates i.e. Income would be Tax Free up to the specified limits and would then be taxed progressively at 10%, 20% & 30% resulting in tax saving.

How creating a Hindu Undivided Family Account would result in tax saving?

Example: 

Let’s assume there are 4 Members in a Family – Husband, Wife and 2 Children. The Income of the Husband is Rs. 30 Lakhs, Income of the Wife is Rs. 20 Lakhs. They also have a ancestral property from which they are earning rent of Rs. 8 Lakhs p.a.

The rent from such a property would either be taxed in hands of the Husband or the Wife or both.

Case 1: If taxed in the hands of the Husband, the husband who is currently in the 30% Income Tax Slab Category would be required to pay 30% of Rs. 8 Lakhs i.e. Rs. 2.4 Lakhs as Tax.

Case 2: If taxed in the hands of the Wife, the wife who is also currently in the 30% Income Tax Slab Category would be required to pay 30% of Rs. 8 Lakhs i.e. Rs. 2.4 Lakhs as Tax.

Case 3: If taxed equally in the hands of both Husband and Wife i.e. Rs. 4 Lakhs each, both the Husband and Wife would be required to pay tax @ 30% on Rs. 4 Lakh = 1.2 Lakhs each by both Husband and Wife thereby leading to a total tax outflow of Rs. 2.4 Lakhs.

However, there is a better way out by which you can plan your Income Tax. As this Income is arising from an asset which belongs to the whole family, this Income shall be taxed in the hands of the Family (provided an HUF is formed) and you would be able to enjoy the benefits of slab rates.

Case 4: If this Rental Income of Rs. 8 Lakhs is taxed in the hands of HUF, the tax payable by the HUF as computed as per the Slab Rates would be Rs. 70,000 to Rs. 80,000 (depending on the income tax deductions claimed by the HUF). Taxing this Rental Income in the hands of the HUF would lead to a Tax Saving of Rs. 1,80,000 p.a. (Rs. 2,40,000 – Rs. 60,000).

For easy understanding of the concept, we explained this article using only Rental Income, but there are many other Incomes as well which arise to the family as a whole wherein the concept of saving taxes by forming an HUF can also be applied.

Benefits and Drawbacks of forming an HUF

1. The major advantage of creating a Hindu Undivided Family Account is that the family gets an extra PAN Card and can split the family income and thereby resulting in tax saving and reducing the tax outgo. This is the major reason why CA’s advise their clients to create a HUF and save taxes of upto Rs. 1.8 Lakhs every year (as explained above). Apart from getting tax deduction up to Rs. 1,50,000 for an individual, it is possible that if an HUF is created by that individual, he will be able to claim higher tax deduction and exemptions under the Income-tax Law because the new tax entity in the form of a Hindu Undivided Family will be eligible to claim separate tax deduction under section 80C of the Income-tax Act, 1961. Likewise, the dividend income and the Long-term Capital Gains on listed securities would also be exempted for such Hindu Undivided Family. The income from Short-term Capital Gain by this Hindu Undivided Family will also be eligible to a lower tax rate of 15 per cent tax only. 
2. Various other tax benefits within the framework of the Income-tax Law are available for the Hindu Undivided Family to save tax. 

However it should be noted that there is a disadvantage as well and that is the fact that all assets of in the name of the Hindu Undivided Family are assets of the family and not of a specific individual. All members of the family have a right in the assets of the Hindu Undivided Family (including an unborn child in the womb of a mother).

Therefore proper caution should be exercised while gifting assets to the Hindu Undivided Family as the whole family would be having a share in the assets of the family as compared to the fact that if these assets were in the name of a specific individual – only that individual would have a right over that asset.

To be Continued...