HUF: The legal hack to double tax benefits and lower your tax outgo

If you want to double your tax benefits, embrace the legal tax-saving manoeuvre known as 'HUF' or Hindu Undivided Family. An HUF is a family that comprises all the persons lineally descended from a common ancestor, including wives. As per the Indian tax laws, an HUF is recognised as a distinct entity. It is subject to tax like an individual taxpayer, and you have to file its tax return separately. 

"HUF is a separate legal entity apart from an individual. This indicates that a person may be assessed in two different capacities- as an individual and as a Karta of his HUF. To lower the taxes, the individual can assess a part of his income in his individual PAN and another part of his income in HUF PAN. This way he can claim the basic tax exemption limit of Rs 2.50 lakh twice. One on Individual PAN and another on HUF PAN," said Alay Razvi, Partner ( Accord Juris LLP, Hyderabad.

In the same way, if the tax-saver investments exceed the prescribed bracket, then he can make the balance payments of tax-saver investments in the name of HUF and claim the tax deductions.

Consider two individuals, both falling under the old tax regime. One has established an HUF, while the other has not. The individual with a HUF reduces his overall tax liability and further invests in tax-saving instruments.

Example: Life insurance premium payable is Rs 2.70 lakh If he claims the premium under section 80C of the Income Tax Act he will be eligible to claim maximum deduction of Rs 1.50 Lakh as prescribed in the said section. But if he makes Rs 1.50 Lakh from the Individual account and the remaining from the HUF account, he can claim a total of Rs 2.70 lakh deduction (Individual Rs. 1.50 Lakhs and HUF Rs1.20 Lakh).

"Under the Income Tax Act, HUF allows members to distribute income, thereby lowering tax brackets for individuals. HUFs can also claim various deductions and exemptions and can also invest in assets like stocks, mutual funds and real estate, independently," said  CA Manish Mishra, Virtual CFO and Growth Advisor.

The HUF can also get life insurance in the name of its members and then claim a deduction under Section 80C of the Income Tax Act on the premium amount paid because it has its own PAN and files returns independently. Additionally, a HUF can deduct such payouts for member salaries. HUF is also permitted to own investments and receive income from them under its own name. HUF is subject to individual income tax rates. 

As HUF is treated as a separate entity for tax purposes, HUF’s income is taxed separately.

The benefits of such an arrangement are explained through a simple illustration by Siddharth Nigotia, Associate, SKV Law Offices:

 Let us assume that one Mr Sharma inherited ancestral property after his father’s demise. His taxable salary income is Rs 20 lakh and rent from house property is Rs 9 lakh. After 30% tax deduction, taxable income would come to Rs 26.3 lakh and tax liability would be Rs 6.25 lakh. Now, suppose Mr. Sharma opted for the transfer of the inherited property to his HUF. Since it is an ancestral property, it can be considered as an HUF’s property. Now, Mr. Sharma’s taxable income would be Rs 20 lakh (as rent from house property would accrue to HUF) and tax thereon would be Rs 4.29 lakh. Since the HUF is taxed as a separate entity, therefore, the taxable income of the HUF would be Rs 6.3 lakh and tax thereon would be Rs 0.40 lakh. Effectively, Mr. Sharma can save tax of Rs 1.56 lakh.

Here's another such illustration 

Tax = 30% of Rs 8 lakh = Rs 2.4 lakh

If equally divided and taxed on both:

Total tax liability = 30% of Rs 8 lakhs x 2 = Rs 4.8 lakh

With HUF:

HUF's tax liability on rental income:

The applicable tax rate for the HUF on rental income is 30%, so the tax liability would be:

Tax on rental income = 30% of Rs 8 laks = Rs 2,40,000

Therefore, the HUF's tax liability on rental income is Rs 2,40,000.

Thus,
 

Example 3


How is HUF set up:

You need to apply for the HUF's PAN and open a bank account in its name. You should also create a legal deed, which contains details such as the name of the Karta and other members of the HUF.The head of the HUF is called Karta, and the other members are called coparceners.

Point to note: An HUF can only be created by Hindu, Buddhist, Jain or Sikh families.

HUF is essentially made up of unmarried daughters, their spouses, and descendants of shared ancestors. "An HUF must be formally registered under its name as soon as it is constituted. Typically, the KARTAàHUF's terminology is used by the HUF. A formal deed is required to support the HUF's creation. The HUF needs to have a specific bank account in addition to a separate PAN Account," said Ashish Aggarwal, Director of Acube Ventures.

Biggest USP:

One way to avail tax deductions is by ‘income splitting’ wherein income earned by the HUF can be distributed among family members, potentially bringing them into lower tax brackets compared to clubbing all income in one individual's return. "Consider a family with an annual income of Rs 20 lakh, without HUF, one individual is taxed at the applicable rates, however, with HUF, the income can be distributed amongst family members, possibly resulting in lower tax rates for each," said Vipul Jai, Partner, PSL Advocates & Solicitors

Benefits of HUF

Aditya Chopra, Managing Partner, Victoriam Legalis - Advocates & Solicitors decodes the benefits of an HUF:

Deductions under Section 80C: HUFs can claim deductions under various subsections of Section 80C of the Income Tax Act. For instance, HUFs can claim deductions for investments made in specified avenues like Provident Fund (PF), Public Provident Fund (PPF), Equity Linked Savings Schemes (ELSS), remuneration paid to the members and life insurance premiums. The maximum deduction allowed under Section 80C is Rs. 1.5 lakhs. 

Income Splitting: By forming an HUF, income can be split among family members, including the Karta and coparceners, potentially leading to lower tax liabilities for each individual member. This income splitting strategy can be particularly advantageous for families with members in different tax brackets.

Asset Transfer and Management: HUFs allow for the transfer of assets within the family without tax implications. Assets can be transferred to the HUF, and any income generated from those assets is taxed in the hands of the HUF, potentially resulting in tax savings. 

Succession Planning: HUFs facilitate efficient succession planning and wealth transfer among family members. Assets held by the HUF can be passed down through generations with reduced tax implications compared to individual transfers.

Continued Tax Planning Opportunities: Once formed, HUFs offer ongoing tax planning opportunities. HUFs can adapt to changing tax laws and regulations to optimize tax savings over time.

Disadvantages:

However, HUF may entail certain disadvantages as it may lead to complexities in management and division of assets which can result in conflicts among the HUF members over property and income distribution. Additionally, the dissolution process of a HUF can be legally complex and time-consuming as such dissolution or division has to be consensual amongst all members.

Keshav Singhania, Private Client Leader, Singhania & Co. LLP explains these in detail: 

Lack of Individual Autonomy: It's important to recognize that HUF accounts typically fall under the purview of the Karta, with other members possessing limited control and decision-making authority over the assets and funds contained therein. This lack of individual autonomy may not align with everyone's preferences, particularly for those who prioritize personal control over their financial affairs.

Complexity: From establishing the HUF to complying with regulatory requirements, navigating the intricacies of HUF management requires careful attention, expertise, and professional guidance. Moreover, the division of property within an HUF can be a complex and arduous undertaking, often giving rise to disputes, especially in cases where properties are indivisible or individual shares cannot be distinctly delineated. The underlying rationale behind retaining property within the HUF was to curtail the transfer or alienation of assets by a select few within the family.

Potential Conflicts: Disagreements among HUF members, particularly regarding the appointment of the Karta (head of the HUF) or the distribution of assets, can lead to conflicts and discord within the family. Resolving such disputes may require mediation, legal intervention, or family consensus-building efforts.

Changing Tax Laws: Recent changes in tax legislation have impacted some of the tax benefits associated with HUFs, reducing their attractiveness as a tax planning tool. As tax laws evolve, individuals need to stay informed about the implications of these changes on HUF taxation and reassess the viability of maintaining an HUF structure.

Who should set up a HUF?

The HUF should ideally be formed by individuals with a sizable family estate or income that can be legally separated among family members. It is beneficial for those looking to save on taxes through income splitting. Further, HUF is also suitable for Hindu families wanting to manage ancestral property or business collectively. Moreover, HUF may also be formed if so desired by members of same ancestral lineage for maintaining family ties. 

"Families with a single high earner can benefit significantly from the multiple exemptions available to an HUF. Individuals looking to build wealth for future generations can use the HUF to hold assets and investments, potentially reducing tax burdens for future income generated," said Vipul Jai, Partner, PSL Advocates & Solicitors.

HUFs can be beneficial for:

Key points to note, as explained by Value Research: