How to get tax benefits under a Hindu Undivided Family (HUF)

Published: May 21, 2020 at 10:17 am

Last Updated on May 21, 2020 at 10:17 am

Hindu Undivided Family (HUF) is a distinct legal entity and consists of individuals who have lineally descended from a common ancestor, including their wives and children. Let us see how a HUF is formed and what are its various tax benefits.

About the author: Anjesh Bharatiya is a 30+ taxman by profession and a Chemical Engineer by education. He has been an investor in the stock market since age 15! He likes to write about personal finance, stock markets, government policies, taxation, philosophy and football.  Also by Anjesh: How to use Tax benefits on HRA and home loans and Want to trade in stocks? Here is how your income will be taxed. SEBI Registered Investment Advisor Sriram Jayaram from Arthagyan advisors reviewed the article and provided helpful comments.

Editors note:  The govt has made it progressively harder to create new HUFs. Therefore it is better to consult an expert while creating one. The best in the business is Ashal Jauhari the admin of Facebook Group, Asan Ideas for Wealth. While I am personally opposed to the idea of a community-based tax rule, this article is for those interested. It is my hope that we shall transition to a Uniform Civil Code sometime in the future getting rid of community-based rules.

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A HUF consists of a Karta (a senior-most member of the family*), co-parceners (all members of the family, including daughters with effect from 09.09.2005 when The Hindu Succession (Amendment) Act, 2005 came into operation) and members (females coming into the family after marriage & adopted children). *  The Hon’ble Delhi High Court ruled in favour of a woman being the Karta of a HUF in Jan 2016. So women can also become a Karta.

Members of a HUF are not entitled to ask for partition (right reserved for Karta & co-parceners) but are entitled to maintenance and proportionate share in the joint assets as and when partition takes place. You can form a HUF if you are a Hindu or a Sikh or a Buddhist or a Jain. Although the name suggests a joint family as the essence of the HUF entity, it can be also be formed by a married couple in a nuclear family unit.

HUF can be formed by two individuals at least one of whom should be a male member of the family. Since the HUF is taxed separately from its members, it can be used to reduce your tax outflow very efficiently. In the article below, we will be using the terms ‘Members’ and ‘Co-parceners’ interchangeably since there is practically no difference between the two except for the right to call for partition. Let us see how a HUF is formed and what are its various tax benefits.

How to form a HUF

A HUF is automatically created at the time of marriage i.e. the start of a new family. However, to take benefit of the HUF structure, it needs to be registered via a legal deed containing details of its members & co-parceners.

Receipt of fund from the parents or in-laws to start the operation of HUF has to be included in the legal deed. The deed is a declaration to be signed by the Karta with relevant details on a stamp paper which needs to be notarized – Sriram Jayaram

Thereafter, a PAN is to be obtained in the name of the HUF and a bank account can also be opened in its name. The Karta of the HUF has the power to sign on all documents on behalf of the HUF. However, he may delegate such powers to other adult members of the HUF too.

A HUF is required to have some assets or property which can be provided for in different ways. This includes ancestral property, assets/property received through will and assets that come from a gift. A HUF can also have assets or property contributed to the HUF by its members.

Ancestral property may be defined as the property which a man inherits from any of his three immediate male ancestors, i.e. his father, grandfather and great grandfather. Ancestral property & property received through a will are tax exempt in the hands of the HUF.

Although any gift received by the HUF from its members is non-taxable as per Section 56 of the Income Tax Act, 1961, the income accruing to the HUF from such a gift will be clubbed with the income of the member making the gift as per provisions of Section 64 of the Income Tax Act, 1961. Thus, transfer of personal assets of the members to the HUF is best avoided.

As a workaround, the HUF can invest such sums into taxfree bonds. Since there is no tax on interests from such bonds, there is no clubbing of income involved. The interest of tax-free bonds can in future be invested by the HUF free from the clubbing provision. – Sriram Jayaram.

If there is no ancestral property, a HUF can be easily started by receiving some gift in its name from your relatives or friends. This may be in the form of cash or assets. The gift received from close relatives is tax-free. As per the Income-tax Act, close relatives consist of the spouse, brother and sister of self and spouse, brother or sister of parents or parents in law, any lineal ascendant or descendant of self or spouse and spouse of any of the relatives mentioned here.

A gift from any other person is tax-free only up to Rs 50,000/- in a year. The income arising from such gifts or property will be the income of the HUF and will be taxed separately. The HUF can also give and receive loans from its members.

Various tax benefits of a HUF

Since a HUF is a separate entity for taxation purposes and is taxed at the same rate as individuals, it enjoys all the available deductions and exemptions that can be used to offset the tax payments on its income. Therefore, it can be used to reduce tax outgo through the division of income between multiple assessable units. Some of the advantages are listed below:

  • An income of up to Rs 2,50,000/- earned by the HUF is tax-free as per the tax slabs for the Assessment Year 2020-21.
  • A HUF can be used to carry out any business separate from its individual members and thus, can be used to offset the tax liability which would arise in the case of a single joint business.
  • Deductions under Section 80C can be claimed by the HUF. For example, a HUF can take insurance policy in the name of its members and make payments of the insurance premium which can be claimed under Section 80C. A HUF can also contribute to the PPF accounts of its members and claim the contribution as a deduction under Section 80C. A HUF can also open five-year duration tax saver Fixed Deposits with banks or invest in Equity Linked Saving Schemes (ELSS) and can claim the investment as a deduction under Section 80C.
  • Under Section 80D, the HUF can also claim a tax deduction of the health insurance premium paid for health insurance policy taken in the name of its members. Section 80DD deductions for maintenance of HUF member(s) with disability and Section 80DDB deductions for payments on medical treatment of specified diseases are also available.
  • A HUF can also claim deductions on donations made to various charitable organizations under Section 80G.
  • A HUF can make investments from its income in any instrument and the income arising from such investments will be taxable in the hands of the HUF along with all the concerned taxation benefits. For example, if a HUF makes Long Term Capital Gains (LTCG) of up to Rs 1,00,000/- on its equity investments in a year, the said income will be exempt from tax.
  • A HUF can pay a salary to its members for contributing to the functioning of the HUF which can then be claimed as a deductible expense from its income. However, there must be some justifiable contribution to the salary earning members to the working of the HUF & management of its affairs.
  • A HUF can also claim deduction on interest paid on house property of up to Rs. 2,00,000/- in a year. However, the house property must be in the name of the HUF or jointly in the name of the HUF and one of its members. The principal repayments can be claimed as deduction under Section 80C. The house property can either be self-occupied or rented out. The rental income from a rented-out property in the name of the HUF is taxed only in the hands of the HUF and therefore, can be used to reduce the tax liability against a situation where the house property is in the name of an individual member.
  • If a member of the HUF receives House Rent Allowance (HRA) from his/her employer and resides in the joint property owned by the HUF, he/she can pay rent to the HUF and subsequently claim deduction on the HRA received.
  • Since the income after tax of the HUF is the family’s income, the Karta can use it for family expenses and can also distribute it among the members without any further tax liability.
  • The HUF can also be a non-resident if the management & control of the HUF is done from outside India.

Disadvantages of the HUF structure

The main disadvantages of a HUF arise from the joint ownership of assets under the HUF structure. Any asset which becomes part of the HUF is a common asset and the previous owner (who could be a member or a relative who gifted the asset) relinquishes all ownership rights over the asset. Thus, all assets of the HUF are family assets and no specific member has ownership over them. In the present times, disillusionment with the joint family structure is increasing and in such cases, it can be very difficult to get out of the HUF with any asset in your own name. Only when all the members of the HUF are in agreement can a property be shared among the members. Similarly, shutting down a HUF may also turn out to be a pain point since the consent of all co-parceners of the HUF is required to do so and requires a partition of the HUF’s assets. This can lead to legal disputes and general ill-will among the family members.

Some other disadvantages of HUFs are:

  • Since every addition of a person by marriage or birth to the family results in an addition to the HUF, the HUF structure can become unwieldy and too complex after a while.
  • The HUF continues to be assessed until its partition. Thus, once an income tax return is filed for the HUF, you have to continue filing the returns till the HUF is dissolved/partitioned, even if there is no income. Any claim for partition is also made to the assessing officer.
  • A HUF is required to file its income tax returns separately which means a separate set of tax calculations and form filing, including an audit of accounts as per its turnover. However, this is a natural accompaniment to the tax savings.
  • In a peculiar case, an adopted child can only become a member of the HUF and not a co-parcener i.e. he/she cannot ask for partition of the HUF.
  • The state of Kerala does not recognize HUFs. So if members of a HUF purchase property in Kerala then it will not be considered as part of the HUF.
  • The members of the HUF are liable to the clubbing provisions in the Income Tax Act if they transfer an asset to the HUF without appropriate consideration.

HUF is an attractive vehicle for tax saving available to most taxpayers. The process for starting it is also straight forward and does not require much time or resources. However, the HUF structure also brings with it the concept of joint ownership of assets and equal rights over them. Thus, it may become difficult to manage and partition in case of a large family with competing viewpoints of the HUF members. Therefore, it is very important to carefully weigh the pros and cons of the HUF structure with a view towards future complications and not jump in for the tax savings alone.

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