Can HUFs lower your tax liability?
An HUF is regarded as a separate taxable entity, different from its members
Gautam Nayak, Mint 17/8/2012
I am sure many of you must have wondered whether it is possible for you to have a Hindu Undivided Family (HUF) as a separate taxable entity to lower your income-tax liability, but could not go ahead because you were not clear as to what is an HUF and how one can go about it.
As the name itself suggests, an HUF is a family of Hindus. Therefore, you have to be a Hindu to be eligible to have an HUF. Even Buddhists, Jains and Sikhs are regarded as Hindus and accordingly can have HUFs.
Members of HUF
How many members should the family have in order to be considered an HUF? Normally, the family would consist of a male, his wife, three generations of male descendants, their wives and unmarried daughters of the top three generations. The male members were regarded as coparceners, while the females were regarded as members. The Hindu Succession Act has been amended a few years ago, whereby all daughters are also regarded as coparceners, irrespective of whether they are married or not. Therefore, today all members of an HUF would be coparceners, except the wives, who would be merely members of the family. The difference between a coparcener and a member is that a coparcener can demand partition of an HUF by distribution of its property among its coparceners. On such partition, only coparceners have a share in the property, though other members are entitled to receive maintenance from the HUF. The seniormost coparcener would be the karta (manager) of the family.
Who can use it for tax purposes?
There needs to be at least two members, one of whom is a coparcener, to constitute a family under Hindu law, but for tax purposes, unless a family consists of at least two coparceners, it is not taxed as an HUF, but its income is taxed in the hands of the sole coparcener. Thus, normally a husband and wife would not be taxed as an HUF, except where the funds have been received by the husband on partition of a larger HUF (an HUF of his forefathers). However, today, a husband, wife and son or daughter would constitute an HUF for tax purposes. The HUF is already in existence, though it may not have any funds and therefore no income.
What is the benefit of HUF for tax purposes?
An HUF is regarded as a separate taxable entity, different from its members. The rates of tax applicable to an HUF are the same as those applicable to individuals—the slab rates of 10%, 20% and 30%. Therefore, if an HUF has income of Rs.10 lakh, it would pay income-tax of Rs.1.3 lakh, whereas if the same income were added to the income of the individual who is in the highest tax slab, he would have paid a tax of 30% on such income, which comes to Rs.3 lakh. If the income is derived by the HUF, there is a tax saving of Rs.1.7 lakh.
Is it so simple?If it is so simple, why are more people not filing separate returns for their HUFs showing such separate income and paying tax at lower rates? What you need to keep in mind is that tax laws do not permit you to divert your own income to the HUF. For instance, your salary income is taxable in your own hands and cannot be taxed as income of an HUF. Only the income attributable to funds invested of the HUF itself or the income from business carried on by an HUF is taxable as the income of HUF.
How does one build up funds of HUF?
If a member of the HUF converts his own personal savings into HUF funds, the clubbing provisions apply and there is no tax advantage. If the HUF does not have inherited funds, the only way it can build up its funds is out of its income, by receiving gifts from close relatives and friends or by receiving an inheritance under a will, where the HUF itself is a beneficiary. Funds received on inheritance from a parent who has expired without leaving a will or who has made you the beneficiary, would not be treated as HUF funds.
Again, here you need to keep in mind the provisions of income-tax, taxing gifts received from persons other than relatives. So far as an HUF is concerned, only a member of an HUF is regarded as a relative, and in the case of such gifts from relatives, the clubbing provisions apply. Therefore, effectively only gifts of up to Rs.50,000 a year can be received by the HUF from persons other than members of the HUF, without such gifts being taxable. Of course, the basic exemption limit to the extent not utilized by other income would also be available and an HUF which has no income can receive gifts of up to Rs.2.5 lakh a year without paying any tax on such gifts. It is essential that the gifts are genuine, and from close relatives and friends, or else you may end up paying tax at 30% of the value of such gifts received, they being treated as unexplained cash credits.
Given this, do consider whether it is possible for your HUF to build up its funds and income. Of course, there are various other issues which you need to keep in mind when you are building up the funds of an HUF. We will discuss these in a subsequent article.
Gautam Nayak is a chartered accountant.
Make sure HUF norms offer you tax benefits
Pankaj Mathpal, Financial Chronicle 23/8/2012
A Hindu undivided family (HUF), or, a joint Hindu family, is a creature of law. Therefore, you become member of HUF by your status and it cannot be created by an agreement between two parties, except in case of adoption. For instance, a daughter-in-law automatically becomes member in her father-in-law’s HUF on marriage and children become member of their father’s HUF by birth.
HUF stakeholders: Under Hindu law, HUF is defined as a family that consists of all males, lineally descended from a common ancestor and their wives. After amendment of The Hindu Succession Act, 1956, with effect from September 9, 2005, all daughters, whether unmarried or married, are coparceners of the HUF. Daughter continues to remain the coparcener in her father’s HUF even after she gets married, and also, becomes member of her husband’s HUF as well.
There should be minimum two members to constitute the HUF. As a rule, the father or the eldest male member of the family becomes manager or ‘karta’ of the HUF, but, in the light of the amendment in the Hindu Succession Act in 2005, an unmarried daughter, in the unfortunate death of her father, can become the karta of the HUF, if she has no brother. In the event of the death of the karta and in the absence of any male member, two females can continue to run the HUF and the senior female can take over as the karta.
Creating HUF: HUF is a creature of law, and hence, it cannot be created by acts of two parties except in case of adoption. Actually, when we talk about creating HUF, we actually imply creating a separate entity for tax purposes. HUF comes automatically into existence at the time of marriage of an individual, and no formal action needs to be taken for the same. HUF is governed by Hindu law and not by the I-T Act. Therefore, individuals belonging Hindu, Jain, Sikh and Buddhist, to whom the Hindu Succession Act applies, are only eligible to form HUF, and other religions are not allowed.
Tax planning with HUF: HUF is assessed as a separate entity in income tax. It can have its own assets and liabilities and even a regular source of income that can be taxed separately. For example, if an ancestral residential property is rented out, then, the rent would be considered as the family’s income and not as income of an individual. The income of the HUF is taxable in the hands of the HUF and not in the hands of any individual. The HUF is liable to pay tax if its total income exceeds Rs 2,00,000 in FY13 (AY2013-14). The rate of tax is the same as applicable to an individual. The HUF can claim deduction from gross total income of the HUF under section 80C to 80U of the I-T Act as in case of an individual, but, HUFs are not permitted to open a PPF account, with effect from May 13, 2005.
You can save lot of tax by dividing your income between individuals and the HUF. For instance, if you have a total income of Rs 10 lakh from your existing proprietary business in financial year 2012-13, you are liable to pay tax of Rs 1,33,900. Now if you set up a new business and earn additional income of Rs 5,00,000, you will pay additional tax of Rs 1,54,500 because you have already crossed the limit of Rs 10 lakh and are liable to pay 30 per cent tax on the income exceeding Rs 10 lakh. It means you pay total tax of Rs 2,88,400 (inclusive of education cess). But, if you have additional business under the new entity called HUF, you will pay the tax of Rs 2,06,00 on your gross total income of Rs 5,00,000 earned under HUF. As your total income will come down to Rs 4,00,000 after claiming deduction of Rs 1,00,000 towards investment in various eligible schemes, Section 80C of the I-T Act, and you will pay tax only on Rs 2,00,000, exceeding the basic exempt limit of Rs 2,00,000.
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