HUF - A Way To Save Income Tax

An HUF allows families to pool their assets and be taxed separately from its members, offering several tax benefits under the Income Tax Act, 1961. In this article, we’ll discuss how creating an HUF can help you reduce your tax liability. 

What is a HUF?

• A Hindu Undivided Family (HUF) is taxed separately from its members.
• A Hindu family can come together and form a HUF. 
• Buddhists, Jains, and Sikhs can also form an HUF. 
• HUF has its own PAN and files tax returns independent of its members.

Residential Status of HUF

Resident: A HUF would be resident in India if the control and management of its affairs is situated wholly or partially in India.

If the Karta of a Hindu Undivided Family (HUF) is resident and ordinarily resident in India, then the HUF is also treated as resident and ordinarily resident.

However, if the Karta is resident but not ordinarily resident, then the HUF is considered resident but not ordinarily resident.

Non-Resident: If the control and management is situated wholly outside India, it would become a non-resident.

Members of HUF

• The head of HUF is called Karta.
• There should be minimum 2 members to form a HUF.
• Members include all individuals in the family, such as the grandfather, father, son, grandson, mother, wife, and unmarried daughters.
• Coparceners, however, are a subset of members. They are those who acquire their status in the HUF by birth. 
• They include male and female descendants, but not women who marry into the family—they are members but not coparceners.
• Importantly, only coparceners have the legal right to demand partition of the HUF property.
• Daughters are also considered as co-parceners. Being a coparcener, she can claim the partition of assets of the family.
• All the coparceners are liable for their proportion of the share in HUF. Whereas, Karta has unlimited liability on the dues of HUF, including tax dues.

How to Form an HUF?

Step - 1: Draft a legal deed in a stamp paper, clearly specifying the structure, members, Karta, coparceners, and business of HUF. The members of HUF should sign on the deed. 

Step - 2 : Obtain a separate PAN for HUF.

Step - 3: Create a separate bank account for HUF.

One person cannot form HUF, it can only be formed by a family. A HUF can be created upon marriage. It includes the husband, wife and their children.

Tax Implications of Forming a HUF

HUF Taxation

• A HUF is taxed separately from its members. It has its own PAN and files a separate tax return.
• Therefore, it can claim deductions or exemptions allowed under the tax laws separately. For example, if you and your spouse along with your 2 children decide to create an HUF, all four of you as well as the HUF can claim a deduction for Section 80C.
• HUF can pay a salary to its members if they contribute to its functioning of the HUF. This salary expense can be deducted from the income of HUF.
• Investments can be made from HUF’s income. Any returns from these investments are taxable in the hands of the HUF.
• A HUF is taxed at the same rates as an individual.

How to Save Taxes by Forming HUF - An Illustration

Let’s understand how an HUF is taxed with an example – After the death of his father, Mr Rajesh Chopra decides to start a HUF with his wife, son, and daughter as members. Since Mr Chopra had no siblings, the property held by his father was transferred in the name of the HUF. The property held by late Mr Chopra earns an annual rent of Rs 7.5 lakhs. Mr Rajesh Chopra has an income from salary of Rs 20 lakh. By creating a HUF, Mr Chopra can save tax, see below.

Due to this tax arrangement, Mr Chopra saved tax of Rs 1,57,300. Both HUF and Mr Chopra (as well as other members of the HUF) can claim a deduction under section 80C. Furthermore, the income of the HUF can be invested by the HUF and will continue to be taxed in the hands of the HUF.

Disadvantages of Forming an HUF

Though HUF seems like the perfect way to save tax as a family, it comes with its own drawbacks.

Equal rights of members: The greatest disadvantage of opening a HUF is that its members have equal rights on the property. The common property cannot be sold without the concurrence of all the members. Any additions to the family, by way of birth or marriage, become a member of the HUF and get equal rights. A HUF can get too large to manage.

Partition: The only way a HUF can be dissolved is by a partition. All members have to agree to dissolve the HUF. Under a partition, assets are distributed to members which can lead to a lot of disputes and can be a lot of legal hassle.

HUF continues to be assessed as such till partition: Once a HUF is formed, you must continue to file its tax returns, unless a partition takes place. Any claim for partition is made to the assessing officer. The assessing officer, on receiving such a claim, must make an enquiry after giving due notice to the members. Income from the property which was partitioned is taxed as individual income of the member. If the member forms another HUF with his wife and children, the income of the property which was transferred from the original HUF is taxed in the hands of new HUF.