With HUF, reduce the puff on taxes

Meera Siva | Updated on March 27, 2014


By forming a Hindu Undivided Family, inherited assets can be made less taxing

Blood is thicker than water especially when it comes to making and conserving wealth. The Indian way of families and branches living under the same roof and doing business has got the legal stamp of HUF or Hindu Undivided Family. The HUF has a separate identity that can come in handy to save on taxes.

An HUF is easy to incorporate. All you need to do is execute a deed on a stamp paper, after identifying the Karta, in whose name the HUF will be formed, and constituents. A minimum of two members are needed and there are rules governing as to who can be members and co-parancers (members with a right to demand partition).

An HUF can have assets, income and expenses that is different from that of individuals. Assets that can be attached to an HUF include property, business, jewels or cash. The assets must have been inherited or given as a gift and cannot be self-earned, says Lakshminarayan, a practising chartered accountant. Also, any gift received by the members of an HUF (on birthday, marriage, etc.) can be added to the assets of HUF.

This feature makes the HUF an effective tax management tool. Take the case of a family where the husband and wife’s taxable incomes are ₹15 lakh each. Additionally, they have some inherited property or corpus that gives an annual income of ₹5 lakh. This income will normally be taxed for either of the couple or split between them. Either way, the income will be taxed at 30 per cent rate.

But if an HUF were to be created and the inherited asset assigned to it, the income of ₹5lakh would be taxable for the HUF and not to the couple. The tax in this case is lower, as the HUF can get a standard deduction of ₹1.8 lakh and the tax rate for the remaining income will be only at a lower bracket.

Operating an HUF

These assets may earn income and there are no restrictions on where the asset and subsequent income can be invested. For example, an HUF is free to invest in stocks, mutual funds, business or property.

An HUF must pay tax for all sources of income earned by these assets and also file returns. The Karta of the family is entitled to receive remuneration for carrying out the duties towards the family. Additionally, an HUF may also distribute gifts to its members, with the consent of all members. It can borrow and also provide loans to its members.

Women and HUF

While the role and rights of men in HUFs are clear, those of women are not. Unsurprisingly, the traditional HUF, which is based on the Hindu Succession Act of 1956, had no gender equality. For example, while the Constitution allows women to claim a share of their father’s assets, HUFs did not allow them the right to inherit ancestral property till a 2005 amendment addressed the discrimination.

The amendment conferred rights on female members to become co-parceners directly. This means that women now have equal rights to the family property. Women can demand the partition of an HUF to get their share of property. The partition can be in full (Except in some cases the HUF ceases to exist and all co-parceners get their share) or partial (at least one member takes her share while others continue to be a part of the HUF), says Premnath Rai, PRA Law Offices, Advocates, New Delhi.

But even after the 2005 amendment, women cannot become the Karta except in some cases. The senior-most male member of the HUF is given this right and on the death of the Karta, the position passes to the next senior-most male member in the family.

However, a woman can be a Karta after the demise of the male head under three situations, says CA Karan Batra, Founder, Chartered Club, an online Web site for chartered accountants. One, when the sons are minors and she acts as their guardian.

Two, when the male members are not in a position to act as Kartas and have given her the permission to manage the family affairs. Three, when there are no male members in the family.

An HUF that has only female members can continue to exist and one of the female members will be the Karta. So, if all the children are daughters, the HUF can continue with the mother as the head and daughters as co-parcerners. Also, a widow can induct a co-parcener into the family by adoption, says Karan Batra.

Issues to watch

The main issue for an HUF is when a member decides to split. Originally, partial partition of an HUF was allowed when a member wanted to leave. “After the amendment made to the Hindu Succession Act in 2005, partition of HUF asset can be made only as provided in the Act,” says Rai of PRA Law Offices.

Another issue is when the Income-Tax Department challenges the validity of HUF status, says Sundararaman, a practising chartered accountant.

He says questions arise about the intent of transactions such as loans and source of assets; and one must be able to provide records to clarify the doubts raised. In general, you need to maintain books of accounts and all the paperwork for the HUF account.

Also, property which is part of an HUF asset may be difficult to sell due to the presence of many claimants. While the Karta may be entitled to sell the property, the buyer may not be aware of other members such as married daughters and minors, who may also have a share. Buyers tend to be wary as this may lead to a challenge in court.

The right to property also varies from State to State, Rai points out. For instance, the joint family system among Hindus of Kerala is not recognised and hence birth in a family does not give an automatic right to property.

In West Bengal and Assam, only the sons get property rights after the death of the father. The father, therefore, has the absolute right to dispose of the property.

Published on March 27, 2014

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