Forming an HUF or a Hindu Undivided Family is one of the effective and legal ways of tax saving. Let’s understand what is an HUF, how is it formed and how can you save tax by forming an HUF through this article.
What is an HUF?
HUF stands for Hindu Undivided Family. It consists of all persons lineally descended from a common ancestor, including their wives and unmarried children.
For example: Mr. Kishan Kumar has 2 sons. Both his sons are married and have a daughter each. Now, Mr. Kishan Kumar with his sons, their wives and unmarried children can together form an HUF. In this case, Mr Kishan will be the karta of the HUF being the eldest male member.
How can you save tax by forming an HUF?
As per Section 2(31) of the Income Tax Act, HUF is treated as a “person” for the purpose of tax assessment. That is, the HUF has a separate PAN card and a bank account.
It is taxed separately from its members, and thus income tax exemptions (under Section 80C, Section 10, etc.) can also be claimed separately.
Mr. A inherits an ancestral property after the death of his father, which earns a rent of Rs. 10 lakh annualy. To save tax, he decides to form a Hindu Undivided Family with his wife and son. Mr. A has no siblings and thus the inherited property is transferred in the name of HUF. Also suppose Mr. A has an annual income of Rs. 15 lakh annually from sources other than his ancestral property. Let’s understand how creating an HUF saves tax for Mr. A.
Before forming the HUF, total annual income of Mr. A included both his salary and the rent from property, i.e., Rs. 15 lakh + Rs. 10 lakh = Rs. 25 lakh. The deduction that he could claim for included standard deduction on house property (equal to 30% of rental income) and that under Section 80C (Rs. 1.5 lakh). Hence, in total, income tax benefit of Rs. 4.5 lakh could be availed by Mr. A.
After forming the HUF, total annual income of Mr. A includes his salary only. Thus, the tax benefit that he can claim on his income as an individual under Section 80C is Rs. 1.5 lakh. Notably, rent from ancestral property is considered as the income of the HUF. Thus, the HUF can claim both the standard deduction on house property (equal to 30% of rental income) and also the deduction of up to Rs. 1.5 lakh annually under Section 80C. Thus the, total annual tax benefit that can be claimed by the HUF is Rs. 4.5 lakh, which is in addition to the Rs. 1.5 lakh tax benefit that can be claimed by Mr. A individually. Hence, the total tax benefit that can be claimed after HUF formation is Rs. 6 lakh.
Conditions to form HUF
The following are the key conditions for the formation of a Hindu undivided family:
- There should be a joint family property or an ancestral property.
- All the male members of the HUF should be coparceners. In other words, they should have an equal right over the ancestral property or the undivided estate.
Ancestral property is defined as the property, which a man inherits from any of his 3 immediate male ancestors, i.e. his father, grandfather or great grandfather. Therefore, property inherited from any other relation is not treated as ancestral property.
Step by Step Guide to HUF Formation
The following is a step by step guide to HUF formation:
Step 1: Although, an HUF is automatically created at the time of marriage, it is advisable to create an HUF Deed. HUF Deed is a formal document on Stamp Paper stating the names of the karta and the co-parceners (members) of the HUF.
Step 2: Apply for a PAN card in the name of the HUF. It can be done either online or offline via Form 49A.
Step 3: Open a bank account in the name of the HUF to complete all the HUF transactions.
Once the above 3 steps are competed, the HUF becomes a separate legal entity for the purpose of assessment as per Section 2(31) of the Income Tax Act.
Tax Benefits of forming an HUF
The key tax benefits of HUF formation are as follows:
- Extra PAN Card: Formation of HUF allows you to get an extra PAN Card. As a result, you can split your family income and claim additional deductions as per the Income Tax Act, 1961.
- Claim Deductions: An HUF can claim Income Tax deductions like an individual under Section 80C as well as u/s 10 to 13A of the Income Tax Act, 1961.
- HUF can pay salary to its members and show it as an expense. This will reduce the annual income of the HUF and also decrease the overall income tax payable.
Note: HUFs should file their Income Tax Return by 31st July of the relevant assessment year. This last date may be extended by the Income Tax Department through an official notification. Moreover, HUFs are taxed as per the same income tax slabs as those applicable to individuals.
Disadvantages of HUF
- All members have equal rights to the ancestral property which is part of the HUF. Thus, HUF property cannot be sold until all the members agree to do that.
- Over time, a HUF can grow very large as any additions to the family, by way of birth or marriage, become members of the HUF.
- Once a HUF is formed, you must continue to file its tax returns as an HUF. The only way to close down the HUF is partition. However, partition requires the consent of all the members and this may lead to long drawn legal disputes.
Frequently Asked Questions (FAQs)
Q1. What is HUF?
Ans. HUF stands for Hindu Undivided Family. It consists of all persons lineally descended from a common ancestor, including their wives and unmarried daughters.
Q2. Who is the karta of an HUF?
Ans. The eldest male coparcener of the HUF is called the karta of the family. He is responsible for all actions taken by the HUF including but not limited to filing of HUF income tax returns.
Q3. Who is a coparcener?
Ans. A person who has a right in the ancestral property by birth and can demand partition in the HUF is called a coparcener. Generally, all the male members of the HUF are coparceners.
Note: As per Delhi High Court decision in December 2015, a daughter can also be the coparcener. A daughter also has legal right on the ancestral property and can ask for partition of the property. However, the female members who were not born in the family and became members by virtue of marriage cannot be coparceners.
Q4. Can a woman become a karta of the HUF?
Ans. In the 2005 amendment to Section 6 of the Hindu Succession Act, 1956, daughters have been put at par with sons. Thus, the female members who were born in the family (daughters) can become karta of the HUF. However, the other female members who came into the family by virtue of marriage cannot assume the role of karta.
Q5. What happens if karta of the HUF dies?
Ans. When the karta of an HUF dies, the eldest son automatically becomes the karta. It should be noted that even if the deceased karta’s wife is alive, the eldest son or the other eldest male member will become the karta. In case the HUF has no surviving male members following the demise of the karta, the eldest surviving daughter (by birth) will become the karta of the HUF pursuant to 2005 amendment of the Hindu Succession Act, 1956.