The Income Tax Act of 1961 offers various tax-saving options to Indians. HUF, or the Hindu Undivided Family, stands out as one of the most effective ways of saving on taxes. Hindu married taxpayers can pool their assets to form a HUF. HUFs are recognised as separate legal entities and taxed independently, allowing individuals to claim tax deductions and benefits under HUF registration apart from their individual deductions. This article highlights what a HUF is and how it can be used as a prudent tax-saving instrument in India.
What is a HUF?
HUF is an abbreviation for the Hindu Undivided Family. A HUF is a legal and tax entity in India. Hindu, Buddhist, Jain, and Sikh families in India can pool their assets to form a HUF and save on taxes. It is based on the concept of a joint family and includes all family members from different generations. However, the HUF is considered as a separate entity for taxation purposes. HUFs have their own PAN Cards and file ITRs independently of their members. The HUF is headed by a ‘Karta’ - generally the eldest male member - who manages the HUF’s affairs. Other members of the HUF are called coparceners. Typically, HUF assets can include gifts, ancestral property, proceeds from the sale of joint family property, property that’s acquired through a will, or HUF member contributions to the common pool.
Residential status of HUF
Now that you understand the meaning of HUF, let’s review how the residential status of a HUF is determined. According to the income tax laws, HUF can be formed by both resident and non-resident Indians. The residential status of HUFs is determined in the following ways:
Resident HUF: If the control and management of the HUF’s affairs is completely or partially inside India, then the HUF is a resident of India.
Non-resident HUF: If the HUF’s Karta resides outside India, the control and management of the HUF is also outside India, making it a non-resident HUF.
Resident and ordinarily resident or resident but not ordinarily resident: A HUF is considered a resident HUF if the Karta satisfies both of the following conditions:
The Karta has been a resident of India for at least 2 years out of the 10 years preceding the relevant financial year.
The Karta has been in India for a period of 730 days or more during the 7 previous years preceding the relevant fiscal year.
If the HUF fails to meet these requirements, it is classified into the resident but not ordinarily resident category.
Who are the members of the HUF?
A HUF includes all individuals belonging to a Hindu family. This means husbands, wives, children, their spouses, and their offspring are all eligible for inclusion in the constitution of a Hindu Undivided Family or HUF. HUF has coparceners who are born into the family, as well as members who become part of the HUF through marriage. According to the HUF regulations, only coparceners have the right to request the partition of the HUF, requesting the division of its assets. Prior to the amendment of the Hindu Succession Act in 2005, the coparcener status could be bestowed on only men born into the family. However, this amendment placed female members born into the family on an equal footing as their male counterparts. As coparceners of the HUF from birth, they can legally claim the partition of the HUF’s assets.
Features of HUF
Now that you understand what is a HUF and how it can be used to save on taxes, let’s review some of its key features:
- Establishment: At least 2 male members are required for the establishment of a HUF. HUF members may or may not have inherited ancestral property.
- Control: The Karta of the HUF enjoys full control and authority over the decision-making process. The Karta may seek advice from other HUF members but is not obligated to accept this advice.
- Continuity: Upon the demise of the Karta, the next eldest member assumes the role of the Karta automatically.
- Liability: Since a HUF functions as a Hindu Undivided Family business, liability is involved. All coparceners have limited liability in the HUF to the extent of their share in the business. However, Karta holds unlimited liability where his personal property may be used to repay the accumulated debts of the business.
- Dissolution: Once formed, a HUF can only be dissolved with the unanimous consent of all its members. Upon mutual agreement and dissolution, the assets of the HUF are distributed among its members.
- Minors: Any child born into the family automatically becomes a part of the HUF by virtue of birth.
Advantages of HUF
A Hindu Undivided Family or HUF offers several benefits, including:
- Tax benefits and simplified tax planning: One of the chief advantages of a HUF is tax efficiency. Individual members of the HUF have to file ITRs, while the HUF itself files taxes as a separate entity, maximising tax benefits.
- Simpler management: The creation of a HUF allows the Karta to have effective control over the decision-making process and can sign relevant documents to make investment decisions on behalf of the family. Having a singular centre of authority streamlines the decision-making process.
- Legal recognition: The HUF structure is legally recognised in India, offering strong legal and judicial backing to the HUF as an efficient tax planning mechanism.
- Financial support: Members of a HUF can easily avail of loans through the HUF and take advantage of deductions on student loans, home loans, etc.
Hindu Undivided Family (HUF) Rules
Key considerations for HUF accounts:
- Family composition: An HUF must be constituted by a family unit.
- Automatic creation: An HUF is automatically formed upon marriage.
- Membership: HUF membership includes a common ancestor and their lineal descendants, encompassing both male and female members.
- Religious eligibility: Hindus, Sikhs, Jains, and Buddhists are eligible to form HUFs.
- Asset holdings: HUFs commonly hold assets acquired through inheritance, gifts, or ancestral property.
- Financial requirements: A dedicated bank account and PAN number are essential for HUF operations.
- Income contributions: Members may contribute their income to the HUF's common pool.
- Tax implications: Tax benefits may be availed for eligible deposits under specific provisions.
- Corpus division: Any division of the HUF corpus necessitates the unanimous consent of all coparceners.
Taxation of Hindu Undivided Family (HUF)
A Hindu Undivided Family (HUF) is a distinct legal entity, recognised by the Income Tax Act. It possesses a unique Permanent Account Number (PAN) and files separate income tax returns.
Key tax implications for HUFs:
- Separate taxation: HUFs are taxed independently, at the same rates applicable to individuals.
- Deductions and exemptions: HUFs are eligible to claim deductions under Section 80 and other applicable exemptions.
- Insurance premiums: HUFs can take out insurance policies on the lives of its members.
- Salary disbursements: The HUF can pay salaries to its members for services rendered, which are tax-deductible expenses.
- Investment income: Income generated from HUF investments is taxable in the hands of the HUF itself.
By understanding these tax implications, HUFs can effectively manage their financial affairs and optimize their tax liabilities.
How to save tax by forming a HUF?
A Hindu Undivided Family is taxed separately from its individual members. A HUF has a separate PAN Card and must file an ITR independently. By creating a HUF, a separate joint Hindu family business is created. As a distinct entity from its members, HUF can claim deductions under Section 80 and other applicable exemptions under various sections of the Income Tax Act. HUFs can also take out insurance policies on each of the members and enjoy tax benefits on the insurance premiums u/s 80(C). If the members contribute to the functioning of the HUF, they may be paid a salary for the same, which is, in turn, deductible from the HUF’s income. Similarly, investments can be made in the name of the HUF, and returns are taxable in the hands of the HUF instead of the individual family members. It is important to note that a HUF is taxed at the same rate as individual taxpayers.
Some of the major tax benefits enjoyed by a HUF includes*:
- HUFs enjoy tax exemption up to Rs. 2.5 lakhs under the old regime and up to Rs. 3 lakhs under the new regime
- Tax deductions up to Rs. 1.5 lakhs under Section 80(C) annually
- Tax deductions can be claimed under various sections like Sections 47 and 54(B, D, EC, F, G).
- Deductions of Rs. 1.5 lakhs on home loan principal repayment u/s 80(C)
- Deductions of up to Rs. 2 lakhs on home loan interest payments u/s 24B
- HUFs can invest in mutual fund schemes like ELSS and enjoy deductions under the Section 80(C) ceiling
- Deductions on capital gains u/s 54 and 54(F)
- Gifts received up to Rs. 50,000 are tax-free
*Note: Some of these deductions are available only under the old tax regime.
Example of how HUF is taxed?
Here's an example of how HUF is taxed for Vishal, who has started a HUF with his spouse and children.
Assumptions
- Salary: Rs. 30 lakh
- Income from house rent: Rs. 10 lakh
Parameters
Parameter |
Vishal's Income Before HUF Formation (Rs.) |
Vishal's Income After HUF Formation (Rs.) |
HUF Income (Rs.) |
Salary |
30,00,000 |
30,00,000 |
- |
Rent from House Property |
10,00,000 |
- |
10,00,000 |
Deduction on House Rent |
3,00,000 |
- |
3,00,000 |
House Rent Income |
7,00,000 |
- |
7,00,000 |
Taxable Income |
37,00,000 |
30,00,000 |
7,00,000 |
Section 80C Deduction |
1,50,000 |
1,50,000 |
1,50,000 |
Net Taxable Income |
35,50,000 |
28,50,000 |
5,50,000 |
Tax Payable |
9,12,600 |
6,94,200 |
23,400 |
Total tax payable by Vishal (including HUF): Rs. 7,17,600
Tax saved due to HUF formation: Rs. 1,95,000
How to form or create HUF?
A Hindu Undivided Family (HUF) can be formed through a simple three-step process:
Step 1: Create an HUF Deed Prepare a legal document outlining the HUF's rules and guidelines. This deed should include details about the Karta (manager), coparceners, and other family members.
Step 2: Obtain a PAN Card Apply to the Income Tax Department for a Permanent Account Number (PAN) card for the HUF. This PAN card is essential for financial transactions and tax filing on behalf of the HUF.
Step 3: Open a Bank Account Open a dedicated bank account in the name of the HUF. This account will be used to manage the HUF's financial transactions and funds separately from individual member accounts.
Understanding HUF formation and structure
The following table provides a comprehensive overview of key aspects related to HUF formation and structure:
Aspect |
Description |
Family formation |
A HUF cannot be formed by an individual; it is automatically created upon marriage. |
HUF composition |
A HUF comprises a common ancestor and their lineal descendants, including wives and unmarried daughters. |
Eligible communities |
Hindus, Buddhists, Jains, and Sikhs are eligible to form HUFs. |
HUF assets |
Typically, HUF assets include gifts, inheritances, ancestral property, proceeds from joint family property sales, and contributions from HUF members. |
Formal registration |
The HUF must be formally registered by creating a legal deed outlining member details and business activities. |
PAN and bank account |
The HUF should obtain a PAN card and open a dedicated bank account in its name. |
By completing these steps, an HUF becomes a distinct legal entity capable of holding assets and conducting financial transactions. Importantly, the HUF's income is taxed separately from its individual members' income.
Disadvantages of HUF
The creation of a HUF poses some serious disadvantages as well:
- Equal rights on assets can cause problems: Each member of the HUF has an equal right to the HUF’s assets. This can result in complications when unanimous consent from all members is needed for distribution or sale.
- Limitations on partnerships: According to regulations concerning HUF, a HUF cannot become an equal partner in a business and the income earned is taxed as HUF income.
- Complex dissolution: Dissolving the HUF is a complex process that requires adherence to different legal norms. Apart from all members agreeing to a partition, the asset distribution itself can lead to disputes among members.
- Reducing relevance: India has witnessed a steady move towards nuclear family structures, with the joint family system quickly losing relevance.
HUFs tax rates - Tax slabs for AY 2024-2025
The Finance Act 2023 has introduced significant changes to the Indian Income Tax Act. Starting from Assessment Year 2024-25, the new tax regime will be the default tax regime for individuals, Hindu Undivided Families (HUFs), Associations of Persons (AOPs) excluding cooperative societies, Body of Individuals (BOIs), and Artificial Juridical Persons.
Options to choose tax regime
Eligible taxpayers have the flexibility to opt for the old tax regime, which offers various deductions and exemptions.
- Non-business income: Taxpayers with non-business income can choose their preferred regime annually while filing their Income Tax Return (ITR).
- Business and professional income:
- Initial choice: Taxpayers with income from business and profession must use Form 10-IEA to opt for the old regime before the ITR filing deadline.
- Subsequent changes: Switching between regimes is allowed only once in a lifetime for taxpayers with business and professional income.
Tax rates for HUFs
The following tax rates apply to HUFs (resident or non-resident) for the previous year:
Income tax slab |
Old tax regime |
New tax regime (Section 115BAC) |
Up to Rs. 2,50,000 |
Nil |
Nil |
Rs. 2,50,001 - Rs. 5,00,000 |
5% above Rs. 2,50,000 |
5% above Rs. 3,00,000 |
Rs. 5,00,001 - Rs. 10,00,000 |
Rs. 12,500 + 20% above Rs. 5,00,000 |
Rs. 15,000 + 10% above Rs. 6,00,000 |
Above Rs. 10,00,000 |
Rs. 1,12,500 + 30% above Rs. 10,00,000 |
Rs. 45,000 + 15% above Rs. 9,00,000 |
|
|
Rs. 90,000 + 20% above Rs. 12,00,000 |
|
|
Rs. 1,50,000 + 30% above Rs. 15,00,000 |
Hindu Undivided Family (HUF) checklist
HUF tax implications and operational considerations:
- Annual income tax filing: The HUF is required to file an annual income tax return, accounting for all income received in its name. It's essential to note that the Karta may be held liable for income diverted to the HUF with the intent to evade taxes.
- Asset ownership and management: Assets contributed to the HUF become common property. The original owner must renounce ownership in favour of the HUF. Consequently, the sale of such assets necessitates the consent of all HUF members.
- Membership and management: The HUF's membership expands with births and marriages within the family. Managing a large HUF, including maintaining accurate records of assets and funds, can be complex.
- Dissolution challenges: Dissolving an HUF is a cumbersome process requiring unanimous consent from all members.
- Karta succession: In the absence of male members, a female member can assume the role of Karta. However, the specific tax implications of this arrangement may not be entirely clear.
- Tax implications of property transfers: Property transferred to the HUF without sufficient consideration will be clubbed with the income of the transferor.
- Separate property and income: Wealth brought into the HUF by a female member from her maiden home remains her separate property, and the income derived from it is taxable in her hands, not as HUF income.
Conclusion
Much like other tax-saving avenues, the creation of a HUF also has certain advantages and disadvantages for the members. On one hand, it is instrumental in lowering tax liabilities and simplifies asset management. On the other, it can create disputes among family members and holds little significance in a rapidly nuclearising family landscape.
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