Tax saving through HUFs

If you have inherited or been gifted property, jewellery or business, you can reduce your tax burden by forming a HUF.

If you are a married Hindu, Sikh, Jain or Buddhist, and don’t belong to the fairer sex, there may be ways to reduce your tax burden by forming a Hindu Undivided Family (HUF).

HUFs are recognised as a separate entity for tax purposes and can have its source of assets, income and expenses that is different from that of individuals. Let’s understand this with an example.

Take the case of a family where the husband and wife’s taxable income is Rs 15 lakh each. Additionally, they have an inherited property or corpus that gives an annual income of Rs 5 lakh. This income would normally be taxed for either of the couple or split between them. In any of these cases, the income would be taxed at 30 per cent rate.

If an HUF was created and the inherited asset was assigned to it, the income of Rs 5 lakh 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 Rs 1.8 lakh and the tax rate for the remaining income will also be only at the lower bracket.

Forming an HUF

So if you have inherited or been gifted property, jewellery or business, you will perhaps be able to reduce your tax burden by forming an HUF.

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 of the HUF. 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).

A PAN card is a must for an HUF. A bank account may then be opened in the name of the Karta followed by HUF in parenthesis. Other authorised persons may also operate the HUF account, on behalf of the Karta.

Assets that can be attached to an HUF include property, business, jewels or cash. The assets attached must have been inherited or given as a gift and cannot be self-earned, says Lakshminarayan, a practising Chartered Accountant. Also, any gifts received by the members of HUF (birthday, marriage, etc.) can be added to the assets of HUF.

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.

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 also get a loan and also provide loan to its members.

Issues to watch

The main issue with HUF surfaces when a member decides to split. Originally partial partition of an HUF was permitted when a member wants to leave. “After the amendment made to the Hindu Succession Act in 2005, partition of HUF asset could be made only as provided in the Act,” says Premnath Rai of PRA Law Offices.

Another issue faced is when the I-T department challenges the validity of HUF status, says Sundararaman, a practising Chartered Accountant. He noted that 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 between states, notes Rai. For instance, joint family system among Hindus of Kerala is not recognised and hence birth in family does not give rise to rights in property. In West Bengal and Assam, the sons only acquire property rights after the death of his father. The father, therefore, has absolute right to dispose of the property.

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