July 12, 2016

Why Advisors shouldn’t ignore the HUF?

Anup Bansal
Co-founder and Managing Director, Mitraz Financial

The Hindu Undivided Family

The Indian Income tax Act recognises a Hindu Undivided family as a separate taxable assesse. No, there is no such distinct tax on families. At least not yet! What this means is that HUF is treated as a separate person just like how companies are treated as separate entities/ assesses.HUF is a family hotchpot which is entitled to the same exemptions and deductions as any other individual taxpayer. Since HUF is taxed as a separate assesse, a basic exemption limit of ₹2.5 lakhs is allowed! Further the HUF can get deductions of up to ₹1.5 lakhs under the various subsections of Section 80, medical deductions of up to ₹25,000 (₹30,000 in case of Senior Citizen) and not to forget the benefit of lower tax slabs.

So, how to create a HUF?

There are certain pre-conditions to start a HUF. One of which requires you to say ‘I do’!

Yes, wedding bells need to ring and signal the process of creating a HUF. It forms a part of the list of joys to look forward to in a marriage. A wedding automatically constitutes an undivided family and the taxman acknowledges the fact. Therefore, no additional requirement needs to be fulfilled. However, few simple formalities need to be completed to create legal existence for the already formed HUF.

The Process

  1. The process to create a HUF starts from creating a deed detailing the members of HUF, the coparceners of the HUF, the address and the source of the funds that forms the corpus of the HUF.
  2. This is followed by an application for a Permanent Account Number (PAN) in Form No.49A.
  3. A bank account for HUF needs to be opened once the PAN has been allotted. (A rectangular stamp (seal) which states the name of the HUF and also the Karta who is signing is essential to open a bank account)

Sourcing the funds for Corpus

Once the bank account is opened, the HUF is ready to function. HUF can earn income from all the sources of income except salary. But now, how does one source the initial corpus for the HUF bank account?

HUF funds and assets are mainly sourced through inheritance, gifts, wills and transfers. However, since HUF is not an individual it cannot have relatives and friends.

The following are few ways of creating initial corpus for the HUF.

  1. Gift from parents. A gift deed has to be created specifying that the gift is towards the son’s HUF and not towards the son.
  2. Gifts from strangers/relatives.
  3. Gifts received on the occasion of marriage can form part of corpus.
  4. Gifts from other bigger HUF like HUF of father, grandfather etc.

What are the tax benefits?

  1. Ancestral properties and wealth can be assigned to HUF, thereby making HUF liable for the rental income and capital appreciation of the assets. This way the family’s overall tax liability is minimised.
  2. The whole family’s insurance requirement can be funded and claimed by a HUF. For example, if a family’s annual insurance requirement is ₹60,000; the same can be funded by the HUF income and also claimed by the HUF under Section 80 deductions. This will also allow the members of the HUF to exhaust their ₹1.5 lakhs limit through other options such as PPF, ELSS and other tax saving instruments.
  3. A new investment portfolio can be created in the name of HUF.
  4. Interest on interest earned is not clubbed. For instance, if ₹1 lakh of wife’s income is invested through the HUF, and ₹10,000 is the interest on such investment, this amount of ₹10,000 is clubbed in the wife’s hand and taxed. However, the return on such ₹10,000 reinvested is not clubbed and will be taxed as income of HUF. Further, HUF can invest ₹1.5 lakhs of wife’s income in tax free instruments to avoid tax when the first return is clubbed.
  5. A business carried out in the name of HUF can enable an individual to save taxes for the entire family and take benefit of the additional exemption limit provided by the HUF.
  6. Remuneration to Karta and other family members is an allowable deduction from income of a HUF.
  7. Loans can be given to HUF members. The HUF may or may not charge interest on the loans given.

Unlike how the name reads, Jains, Sikhs and Buddhists are also permitted to form a HUF.

A ‘Karta’ is the male member of the family who manages the daily affairs. A coparcener is a member of the HUF who has the right to enforce a HUF partition. Only a complete partition is recognised by the income tax act. Partial partition of HUF is not recognised. Further, once a property is put into the pool of assets of a HUF, it cannot form part of a will as no member has an individual right on it.

A HUF is a legal way to save taxes with minimum effort in creating it. With that said, one needs to be aware of and adhere to ways of using it judicially.

Authored by,

Anup Bansal

Chairman & Managing Director
Mitraz Financial Services Pvt Ltd

One response to “Why Advisors shouldn’t ignore the HUF?”

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