How to save tax by forming an HUF?

It is possible to save taxes by creating a family unit and pooling in assets to form a HUF.

Nov 22, 2019 11:11 IST India Infoline News Service

Calculating tax
One of the popular methods used by Indian households to save tax is through the formation of the Hindu Undivided Family (HUF) structure. Unlike a joint stock company, an HUF is not classified as an artificial juridical person. On the other hand, it is an extension of the joint family system prevalent in India. 

Tax savings by forming a HUF

It is possible to save taxes by creating a family unit and pooling in assets to form a HUF. While HUF is not a separate juridical entity, the HUF is taxed separately from its members, which is what makes it a good tool for tax reduction. As per the extant laws, any Hindu family can come together and form a HUF. Other than Hindus, Buddhists, Jains and Sikhs are also allowed to form a HUF. Since HUF is a separate tax-paying entity, it has its own PAN Card and HUF returns are filed separately. 

Can you claim tax deduction under HUF?

Having seen what is HUF, let us look at how the HUF tax benefits arise. Since the HUF is taxed separately from its members, it can claim deductions under Section 80 on its own accord on the HUF income while individuals can also claim such deductions separately. 

What you need to know about HUF tax benefits?

Here are some important points you need to know about the tax implications of HUF:
  • HUF has its own PAN and files a separate tax return, distinct from members
  • Deductions under Section 80 and other exemptions can be claimed by the HUF
  • More importantly, HUF can buy insurance on the life of its members
  • HUF can pay a salary to members which is a deductible expense
  • Any Investments returns of the HUF are taxable in the hands of the HUF
  • HUF is taxed at the same applicable rates as an individual
In short, the HUF allows the family to expense certain items from the common account, pay salaries to members and also invest in its own name. By pooling certain assets and incomes in the name of the joint family, the HUF can become tax efficient.
 
How does the HUF become tax efficient?
The best way to understand the tax efficiency of an HUF is through an illustration of an individual whose income is evaluated with and without the HUF. 

Illustration of HUF 

Pankaj Patel starts a HUF with his wife, son, and daughter as members. Here are some of the key flow details of Pankaj Patel. The property held by Pankaj’s mother earns annual rent of Rs8 lakhs, which he has just inherited. Pankaj is also working in a software company and receives annual salary of Rs22 lakhs. Let us see how Pankaj can use the HUF route to save tax. We shall look at the computation of tax through the HUF and non-HUF route to understand HUF tax benefits.
Financial Details Non-HUF Model Pankaj (HUF model) HUF Income
Salary Received Rs22,00,000 Rs22,00,000
Property Rent Rs8,00,000 Rs8,00,000
Rent S.D. (30%) Rs2,40,000 Rs2,40,000
Taxable rental income Rs5,60,000 Rs5,60,000
Total Taxable Income Rs27,60,000 Rs22,00,000 Rs5,60,000
Section 80C Rs1,50,000 Rs1,50,000 Rs1,50,000
Standard Deduction Rs50,000 Rs50,000
Net taxable income Rs25,60,000 Rs20,00,000 Rs4,10,000
Tax Payable Rs6,03,720 Rs4,29,000 Rs.8,320
 
As can be seen from the above table, there is a clear advantage for Pankaj in forming an HUF and transferring the property into it. There are two reasons for this difference in tax. Firstly, the HUF enables the individual and the HUF to get the benefit of Section 80C. Secondly, since the HUF income is quite small, it falls into the lowest tax bracket. Clearly, Pankaj is saving Rs1,66,400 as tax for the year by opting for the HUF model. 

How to form and register  an HUF?

The tax benefits of an HUF will require a basic registration process and also certain basic pre-conditions to be met. Here are some of the key conditions.
  1. HUF can only be formed by a family; in fact HUF is automatically created at the time of marriage.
  2. HUF consists of a common ancestor and lineal descendants, including wives and unmarried daughters. The family must be Hindu, Buddhist, Jain or Sikh to form HUF.
  3. HUF assets normally come as a gift, a will, ancestral property, property acquired from the sale of joint family property or property purchased by pooling.
  4. For the HUF to have legal validity, it must be formally registered under the extant laws. HUF should have a legal deed. The deed shall contain details of HUF members and the business of the HUF. PAN and bank account must be opened in the name of the HUF.
 
With the gradual waning of the joint family system, the government is planning to scrap the usage of HUFs. But that could still be some time away.

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