Saving taxes through HUF is a valid and lawful thing to do. HUF is treated as a ‘person’ under section 2(31) of the Income-tax Act and is a separate entity for the purpose of assessment. The present article is a discussion on Hindu Undivided Family and how it is used as a way to save taxes under the Income tax law.
Hindu Undivided Family
According to Hindu Law, ‘Hindu Undivided Family is a family which consists of all persons lineally descended from a common ancestor and includes their wives and unmarried daughters. A ‘Hindu Undivided Family is neither the creation of law nor of a contract but arises from status.
HUF may be composed of
- Large Families; or
- Small Families; or
- Nuclear Joint Families
Schools Under Hindu Law
Mitakshara School
- Under this school of law the male child acquires a right in the family property as soon as he is born in the family. As soon as a male child is born, the Hindu Undivided Family comes into existence. The father gets the status of ‘Karta”-the manager of the family. On the death of father this status goes to eldest son in the family till partition of the property takes place. In this school of law, share of each member is not defined. No member can ask what his share is.
Dayabhaga School
- Under the Dayabhaga School which prevails in West Bengal and Assam, a son does not acquire by birth in ancestral property. He acquires interest only on the death of his father.
Formation Of Huf (Criteria)
To form HUF there are some essentials that needs to be fulfilled. These are:
Capital
Capital is one of the major considerations with regards to the set-up of any business entity. A HUF establishes by using the ancestral property, assets gifted by relatives and friends, or received by the HUF through a will.
Members
If a married couple forms HUF, then the child would be integrated into the entity after his/her birth. The person of another religion cannot form an entity, except for Sikhism, Jainism and Buddhism.
On a detailed note, the members of a HUF include a Karta, members, and coparceners. The Karta heads the family with decision-making responsibilities. Any male member could play the role of a Karta with the consent of the family members.
A coparcener is a person who is entitled to his/her share of the property. A coparcener is classified into the following hierarchies:
- A first-degree coparcener could be a first-time holder of ancestral property.
- A second-degree coparcener includes the sons and daughters of the family.
- A third-degree coparcener includes the grandsons and granddaughters of the family.
- A fourth-degree coparcener includes the great grand-sons of the family.
The HUF wouldn’t cease to exist on the death of a sole male member. It would continue to function with the existing female members. However, a widower to a Karta cannot consider as an heir to the throne. An adopted child is entitled to membership but cannot be a coparcener.
Name
As is the case with the establishment of any entity, the name assigned to the HUF shouldn’t be in contravention with any of the specified laws. However, there is no requirement for obtaining name approval.
HUF Deed
HUF may be formed with or without a legal deed, though it is always advisable to pursue a business with a written document. With respect to a HUF, a legal deed consists of details of membership of the HUF, the source of funds, and the likes of it. The Deed acts as proof of the existence of the entity that has been formed.
The document should include a declaration by a family member for the name of the Karta, powers vested with the Karta, and the entitlement of the Karta to hold the transactions on behalf of its members. In addition to it, the document should state the capital that was invested in forming the HUF.
PAN
Followed by the formation of a deed, the Karta is required to obtain a PAN Card, which is an important document for pursuing financial transactions. The application for PAN must be made in Form 49A, either online through the NSDL website or manual means.
The PAN Card must be used by the entity for the filing of income tax returns and claiming applicable deductions. The application for PAN and income-tax return should consist of the signature of the Karta.
Separate Bank Account
As implicit as it might sound, a HUF must function with a bank account, wherein the funds of the entity can be maintained. Maintenance of such bank account is strictly for business purposes, and shouldn’t include the savings of any member.
Income Regarded As Huf Income
- Since the HUF is a separate entity, it can earn income from all the heads except income from salary.
- All income that arises on the investment of the HUF’s funds and utilization of its assets is regarded as income and is separately assessed and taxed.
Reason /logic Behind Forming Huf
One of the major benefits of the Hindu Undivided Family is that it is considered a separate legal entity. This entitles HUF to obtain a separate PAN card and bank accounts in the name of the HUF. Once a HUF is formed, typically the oldest member of the family becomes the “Karta” and is provided with an additional exemption. In addition, the tax slabs are lower when compared to that of regular corporate. Until January 2016, women were not eligible to be the Karta of a HUF. However, the Delhi High Court, in a landmark case, gave the decision in favor of a woman being the Karta of HUF. The decision is yet to be implemented in the Income Tax Act.
Assesement Of Huf
- HUF is a separate and a distinct tax entity. The income of a HUF can be assessed in the hands of the HUF alone and not in the hands of any of its members, unless specifically provided by law.
- However, any sum received by an individual as a member of a HUF, where such sum has been paid out of the family or income of the impartible estate belonging to the family shall be exempt in the hands of the member of the HUF as per Section 10(2).
- HUF cannot make any gift of HUF property to any coparcener or any other person. Any gifts made by HUF are void-ab-initio.
- However, the Karta of a HUF has power to gift out of joint family property for certain approved purposes provided that gift amount is reasonable.
- Coparceners are only allowed to claim partition of HUF. However if any partition takes place in HUF, there should be complete partition of HUF. Partial partition of HUF is not recognized by Income Tax and Wealth Tax Act.
- On partition of HUF, the mother i.e. wife of Karta takes a share equal to the sons and daughter. However, they can mutually decide to take unequal shares. As per section 47 of Income Tax Act, no capital gain shall arise to HUF on distribution of assets on partition of HUF.
Huf As A Tool For Saving Tax
The primary reason behind building a HUF is to get an additional PAN card which would be legally acceptable, as well as to avail the tax benefit. After building the HUF, the members falling under HUF will not have to pay tax individually. The HUF can then start using the new PAN card to file the ITR.
Under the Income tax law, an HUF is treated as an independent person (Separate legal entity) for tax purposes. It means, like you and I, it is a taxable entity and is subject to tax provisions in India. Therefore, like an individual taxpayer, it has all the benefit of Income Tax Slabs, Deductions u/s 80 and the majority of the tax provisions including exemptions which are otherwise available to Individuals.
So, if an individual is able to structure his taxable income or split his taxable income between his Individual self and his HUF, he can claim double benefits for deductions and expenses in both capacities, thereby substantially reducing his overall tax liability. Following are the points which make HUF a tool for saving tax:
- Since, the HUF is taxed as separate entity; the tax slab which is applicable to an individual is applicable here too.
- The HUF as per section 24 of the Income-tax Act is also entitled to claim deduction for interest on self occupied house property of Rs. 1, 50,000 in a year.
- The income of the HUF from dividend or shares or Mutual Funds is fully exempt from income-tax. Likewise, the Long-term Capital Gains on listed securities received by the HUF are also exempted.
- It enjoys the deductions provided under the Section 80C to 80U( 80C,80D,80DDB,80G,80GGC,80IA,80IB,80IC,80IC,80IE,80JJA,80JJAA and 80TTA).
- All the income tax slabs and deductions and exemptions available to individual are also available to the HUF.
- To claim this tax deduction under section 80C the HUF can take out Life Insurance Policies in the name of its members and make payment of the premium which will enable the HUF to claim tax deduction as per section 80C of the Income-tax Act, 1961.
- An HUF is also entitled to claim a separate tax deduction in respect of payment of Health Insurance Premium. This deduction is permissible under section 80D of the Income-tax Act, 1961. The maximum deduction is up to Rs. 15,000 per annum. However, if the HUF takes out Mediclaim Policy etc., for members of the family who are senior citizens then the amount of Rs. 15,000 will be enhanced to Rs. 20,000.Out of this amount up to Rs. 5,000 can also be included for Preventive Health Check up.
- The HUF can further receive a separate tax deduction of Rs. 50,000 on account of maintenance including medical treatment of a dependant member which happens to be a person with disability. However, if there is a severe disability, then the deduction gets enhanced to Rs.1, 00,000.This deduction is available as per section 80DD of the Income-tax Act, 1961.
- If the HUF actually makes payment on medical treatment of a specific disease or ailments as mentioned in the Income-tax Act for the benefit of its members, then a deduction up to Rs. 40,000 will be allowed to the HUF as per section 80DDB of the Income-tax Act, 1961.
- However, if such expenditure is made for a member who happens to be a senior citizen, then the deduction to be allowed will be Rs. 60,000. HUF can also donate to recognized charity trusts and institutions and claim deduction under section 80G of the Income-tax Act, 1961.
Illustration for better understanding
CASE 1:Let’s take the case of Mr X, a married man having two children working in the Corporate Sector and earning a Salary of Rs. 20, 00,000/- per year. His income includes income from investments of Rs. 10, 00,000/-.
He also pays Life insurance Premium of Rs 60,000/- for his family, PPF investment of Rs. 1, 00,000/-. His company deducts PF of Rs. 1, 50,000/- from his Salary. He also pays medical insurance premium for himself and his family of Rs. 20,000/-
| Gross taxable income from all sources | 30,00,000 | 20,00,000+10,00,000 |
| Deductions u/s 80C | 1,50,000 | Basic investments from PF, PPF And ELSS |
| Deductions u/s (80D,80E,80G etc) | 20,000 | Medical insurance premium |
| Net taxable income from all sources | 28,30,000 | ———– |
| Total tax liability | 6,81,345 | ————- |
CASE 2: Let’s assume that Mr X is able to legally shift his income from investments of Rs. 10, 00,000/- to his HUF. He also pays Life Insurance premium of Rs. 60,000/- and PPF of Rs. 1, 00,000/- in his name from his HUF. Let’s see his revised tax outflow in this scenario.
| Gross taxable income from all sources | 20,00,000 | ————— |
| Deductions u/s 80C | 1,50,000 | Basic investments from PF, PPF And ELSS |
| Deductions u/s (80D,80E,80G etc) | 20,000 | Medical insurance premium |
| Net taxable income from all sources | 18,30,000 | ————– |
| Total tax liability | 3,72,345 | ————— |
Tax liability of MR X’s HUF will be:
| Gross taxable income from all sources | 10,00,000 | ————— |
| Deductions u/s 80C | 1,50,000 | Basic investments from PF, PPF And ELSS |
| Deductions u/s (80D,80E,80G etc) | 0 | ————– |
| Net taxable income from all sources | 8,50,000 | ————– |
| Total tax liability | 84,975 | ————— |
Hence tax saving in case 2 is Rs 2, 24,025
Thus, from the above example, it is evident that, Mr X is able to legally shift the incidence of taxable income from his individual capacity to his HUF and make payment of expenses on which he gets tax deductions from his HUF, he is able to save nearly Rs. 2,00,000/- every year.
CONCLUSION
As a law-abiding citizen, it is important to pay taxes regularly. However, it doesn’t mean you cannot utilize the different tax benefits provided by the government. By creating an HUF, you can maximize your tax benefits in the long run. Tax saving is possible by taking advantage of the various provisions contained in the Income-tax Law. Even if a person were to take full advantage of all the provisions contained in the Income-tax Law specially relating to deductions and exemptions, then surely he will be able to save substantial amount of income-tax for his family. Many tax payers resort to illegal activities to save income-tax but frankly speaking, such illegal activities are not a part of tax planning process but are a part of tax evasion process which should always be depreciated. However, one can go ahead with legal ways of saving income-tax and this is possible only when we screen very carefully the provisions contained in the Income-tax Act, 1961 and find out the pointers which are of advantage looking to our facts and circumstances. One such very important way of saving income-tax is to think of forming a separate tax entity in the name of a Hindu Undivided Family. Since HUF is a separate tax entity which is officially recognized and approved under the Income-tax Law. The creation of Hindu Undivided Family helps the tax payers to save their taxes in a legal manner.
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