Tax implications of forming a HUF

 

Tax implications of forming a HUF

How to save tax by forming an HUF?

A HUF is taxed separately from its members, therefore, deductions (such as under Section 80) or exemptions allowed under the tax laws can be claimed by it separately. For example, if you and your spouse along with your 2 children decide to create a HUF, all 4 of you as well as the HUF can claim a deduction for Section 80C. HUF is usually used by families as a means to build assets. Let’s understand in detail.

How is HUF taxed?

• HUF has its own PAN and files a separate tax return. A separate joint Hindu family business is created since it has an entity separate from its members.

• Deductions under section 80 and other exemptions can be claimed by the HUF in its income tax return.

• HUF can take an insurance policy on the life of its members.

• 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.

 

• Let’s understand a 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.

Income from various sources	Income of Mr. Chopra before formation of HUF	Income of Mr. Chopra after formation of HUF	Income of HUF
Salary	20,00,000	20,00,000
House property rent	7,50,000	–	7,50,000
Standard deduction on house property	2,25,000	–	2,25,000
Income from house property	5,25,000	–	5,25,000
Total taxable income	25,25,000	20,00,000	5,25,000
Section 80C	1,50,000	1,50,000	1,50,000
Net taxable income	23,75,000	18,50,000	3,75,000
Tax payable	5,53,625	3,91,400	7,725

Total tax paid by Mr. Chopra & HUF	3,99,125
Tax saving due to forming an HUF	1,54,500

Due to this tax arrangement, Mr Chopra saved tax of Rs 1,54,500. 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. Need help with estimating your taxes as an HUF? Our CAs can help you

3. How to form an HUF?

While there are tax advantages of forming an HUF, you must also meet some conditions –

• One person cannot form HUF, it can only be formed by a family.

• A HUF is automatically created at the time of marriage.

• HUF consists of a common ancestor and all of his lineal descendants, including their wives and unmarried daughters.

• Hindus, Buddhists, Jains and Sikhs can form HUFs.

• HUF usually has assets which come as a gift, a will, or ancestral property, or property acquired from the sale of joint family property or property contributed to the common pool by members of HUF.

• Once a HUF is formed it must be formally registered in its name. A HUF should have a legal deed. The deed shall contain details of HUF members and the business of the HUF. A PAN number and a bank account should be opened in the name of the HUF.

4. Disadvantage 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: Perhaps the worst nightmare of opening a HUF is closing it down. 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. Joint family system losing relevance: HUF was recognised as a separate taxable entity by the income tax department. However, in today’s times, where nuclear families are the norm, HUF is losing relevance. Several cases have come to fore where couples or families are fighting it out on common household expenses, forget to pool in of assets. Divorce rates are rising and therefore, HUF as a tax vehicle is losing importance. 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.

5. Frequently Asked Questions

 

• Who is the Karta of an HUF?
  The head of a HUF is called the Karta, he is the senior-most male member of the family.
• Can a Woman be HUF Karta?
  Yes! Until January 2016, a woman could not be the HUF Karta. But in a landmark case, the Delhi High Court ruled in favour of a female being the Karta of a HUF. However, the same has not been incorporated in the Income Tax Act as yet.
• Who are HUF Coparceners?
  All the members of the Karta’s family can be members of the HUF. The male members are called coparceners, while the females are referred to as just members. The difference between the two is that any of the coparceners can demand partition of the HUF. The female members do not have this right in most parts of the country, except for some states like Maharashtra and Tamil Nadu that have allowed unmarried daughters to function as coparceners. The Hindu Succession (Amendment) Act, 2005 which came into force from September 9th September 2005 removed this gender discrimination by giving equal rights to daughters as sons. The daughters become the coparceners of their father’s families on birth in the same manner as sons and have the same rights as sons in the family properties.
• Can a daughter claim a share in her father’s property where her father had passed away before the amendment made in 2005, giving equal rights to daughters and sons?
  No. Both the daughter and the father has to be alive on the date of the amendment for the daughter to get the benefit, irrespective of whether she has been married or not on that date. If the father has passed away before the amendment date, then she wouldn’t have been a daughter on the date of the amendment. Hence she cannot claim a share in father’s property. a. Are there any incomes which are not taxed as income of HUF? b. The following incomes are not taxed as income of HUF c. If a member transfers his self-acquired property to the HUF without receiving proper sale consideration, income from such property is not taxable in the hands of the HUF. It will continue to be taxed in the hands of the member. d. Personal income of the members cannot be treated as income of HUF. “Stridhan” is an absolute property of a woman, hence income from it is not taxable as income of HUF. e. Income from an individual property of the daughter is not taxable in the hands of HUF even if such property is vested into HUF by the daughter.
• Are there any minimum number of coparceners required for an entity to be taxed as HUF?
  A HUF can be formed with just two members one of whom is a coparcener. But for an entity to be taxed as a HUF, it should have at least two coparceners. For instance, if HUF consists of only the husband and wife, then there is only one coparcener. So it will not be taxed in the hands of HUF except in the case where the funds are received on the partition of larger HUF. It will be taxed in the hands of a sole coparcener.
• Should a HUF always be a resident of India
  It is not necessary that a HUF must always be a resident of India. In case the control and management of the HUF are situated outside India, the HUF would be a non-resident. Where the affairs of the HUF are managed from outside India, the HUF would be a non-resident.
• Karta of HUF sits outside India. HUF is managed by the other members residing in India. Will HUF be a non-resident?
  The residential status of a HUF is determined not on the basis of where the Karta resides but on the basis of where the HUF is managed from. In this case, though the Karta resides outside India, the HUF is managed by members from India and hence the HUF will be a resident of India.
• Can the members of the HUF and the HUF separately claim deduction under Section 80C?
  The HUF being a separate taxable assessee, can claim a deduction under section 80C. However, the member and the HUF cannot claim a deduction in respect of the same investment made or expense incurred.
• Upon the demise of the Karta, who takes over the title ‘Karta’?
  Upon the demise of Karta, the eldest male member of the family becomes the Karta of the family. Even when the deceased Karta’s wife is alive, the eldest son or any other eldest male member of the family will take over that position.
• What happens if the eldest male member of the family is an NRI?
  A HUF is considered to be a resident of India if the control and management of its affairs happen wholly or partly in India. In some cases, the Karta of the family may be non-resident. The resident status of the family will not change to be non-resident only because the Karta is a non-resident unless the decisions concerning the family are made outside India.
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