What is Hindu Undivided Family (HUF) - Features & Tax Benefits

What is Hindu Undivided Family or HUF?

HUF, which stands for Hindu Undivided Family, is a joint family setting wherein the family members are considered a separate legal entity from the HUF for taxation. A HUF is generally formed if the family has any ancestral property, a property purchased from the sale of joint family property, a gift received, etc. It includes only those who descend from a common ancestor, their wives, and their children. Hindu Undivided Family (‘HUF’) is treated as a ‘person’ under section 2(31)​ of the Income-tax Act, 1961 (herein after referred to as ‘the Act’). HUF is a separate entity for the purpose of assessment under the Act.

The head of HUF is called ‘Karta,’ who manages the entire HUF business. The male members of the HUF are called co-parceners, and the female members are called members. A HUF can be created by a married male member. His wife, children, their wives, and their children can all be a part of HUF. Generally, the eldest male member of the family becomes the ‘Karta.’ Now if the Karta has 2 daughters, and the father passes away, the eldest daughter can become the Karta and take forward the HUF business.

Jain and Sikh families even though are not governed by the Hindu Law, but they are treated as HUF under the Act.

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What are the HUF Account Rules?

Here are the conditions that you need to fulfill to form a HUF -

• An individual cannot form it, and you need a family.
• Marriage automatically results in the creation of a HUF
• HUF includes the descendants of a common ancestor, their unmarried daughters, and their wives.
• HUF can be formed by Hindus, Sikhs, Jains and Buddhists
• After the formation of HUF, it should be registered formally with a legal deed, PAN number, and bank account. The deed should also mention the details of HUF members and its business.
• Every member can deposit their income in the common HUF corpus.
• The members can claim benefits under various sections.

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What are the Tax Benefits of Forming a HUF?

HUF has a separate PAN number from its members and can avail the benefit of basic exemption limit of 2.5 lakh. This is not all; there are various other tax benefits of forming a HUF. Let’s discuss them in detail -

• Income Tax Benefits: Since a HUF is a separate legal entity from its members and holds a separate PAN, it can generate income, run its own business, and make investments in shares, property, etc. Along with this, it can also avail of the basic exemption limit of 2.5 lakhs.
• Own a Residential House: As per the Indian Income Tax Act, if you possess more than one residential, self-occupied property, only one is considered self-occupied, and you have to pay tax on the remaining properties. A HUF can own a residential house without paying any tax. Therefore, by registering for HUF, you can own more than one residential property without paying taxes.
• Life Insurance: Just like individuals can avail of a deduction of Rs.1,50,000 on investments in certain schemes and life insurance premiums, HUFs can also avail of a benefit of Rs.1,50,000 under section 80C.
• Investment: An HUF can also invest in tax-saving schemes like ELSS and earn tax benefits up to Rs.1,50,000 under section 80C.
• Health Insurance: You get a deduction of Rs.25,000 annually on the health insurance premium paid for your family under section 80D. However, this deduction can seem insufficient with the rising premiums. A HUF can claim an additional deduction of Rs.25,000, making the total health insurance premium deduction to be Rs.50,000.

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How is the HUF Income Tax Computed?

In order to compute the income of an HUF, one has to first ascertain its income under the different heads of income (ignoring incomes exempted under sections 10 to 13A of the Act). The following points should be keep in mind while computing income:

• If funds of an HUF are invested in a company or a firm, fees or remuneration received by the member as a director or a partner in the company or firm may be treated as income of the family (if fees or remuneration is earned essentially as a result of investment of funds).
• However, if fees or remuneration is earned for services rendered by the member in his personal capacity, it will be treated as the personal income of the member.
• If any remuneration is paid by the HUF to the karta or any other member for services rendered by him, remuneration is deductible from income of HUF if such payment is genuine and not excessive and paid under a valid and bona fide agreement.

The following incomes are not taxed as income of HUF:-

• If a member has converted or transferred without adequate consideration his self-acquired property into join family property, income from such property is not taxable in hands of the family.
• Income of impartible estate (though it belongs to family) is taxable in the hands of holder of estate and not in hands of HUF.
• Personal income of the members cannot be treated as income of HUF.
• "Stridhan" is absolute property of a woman, hence income arising therefrom is not taxable as income of HUF.
• Income from individual property of daughter is not taxable in hands of HUF even if such property is vested into HUF by daughter.

A Hindu Undivided Family (HUF) account offers several tax benefits under the Income Tax Act. Here's a comprehensive look at these benefits:

• Tax Rebates and Deductions
  • HUF accounts can claim tax deductions under Section 80C, just like individual taxpayers.
  • Eligible investments include life insurance premiums, PPF contributions, ELSS, and other instruments allowed under Section 80C.
• Tax-Free Gifts
  • Gifts received by the HUF are tax-free up to ₹50,000.
  • Larger gifts or property transfers can also be tax-free if properly structured:
    • A father with a HUF account can gift property or money to his son’s HUF account.
    • The gift must be explicitly designated for the son’s HUF, not to the son as an individual, to avoid tax implications.
    • Tax benefits for such gifts are covered under Sections 64(2) and 56(2) of the Income Tax Act.
• Investment of Corpus in Tax-Free Instruments
  • The HUF corpus can be invested in tax-free instruments such as tax-free bonds or equity-linked savings schemes (ELSS).
  • Income generated from these investments will be taxable under the HUF's account, which is often beneficial as it allows for lower tax liability compared to individual taxation.
• Additional Tax Filing Advantages
  • A separate PAN is issued for the HUF, allowing it to file income tax returns independently.
  • This provides the family with an additional avenue to manage and optimize tax liabilities.

Let us understand this with an example -

Dhairya and Khushi are married and have a son named Tanmay. Khushi earns Rs. 10 lakh per year. Dhairya earns Rs. 18 lakh from his business and Rs.5,00,000 as rent from his ancestral property. Their Tax Liability is as follows:

Now, if they form a HUF, they can

• Divert the rental income and a portion of Dhairya’s income (6,00,000) to the HUF account.
• They can make investments from HUF and also pay insurance premiums from HUF.

Tax Liability is as follows:

As you can see, Dhairya and Khushi saved Rs. 2,21,450 by creating a HUF and diverting some income there.

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Disadvantage of forming an HUF

• Equal Rights on Assets: All family members have equal rights to the family assets, which can lead to complications when consent is needed for asset sale or distribution. Disputes may arise among family members regarding the management and division of assets, leading to conflicts and legal battles.
• Complexity in Dissolution: Closing an HUF can be complicated, with legal and logistical challenges involved in asset distribution among family members. This process can be time-consuming and expensive, especially if there are disagreements among family members regarding the division of assets.
• Decreasing Relevance: With the shift from joint families to nuclear families, the relevance and importance of HUF as a tax-saving tool are declining. In today's modern society, where nuclear families are more common, the benefits of the HUF structure may not be as significant as they once were.
• Disputes and Divorces: Cases of disputes and divorces within the family further complicate the situation, diluting the benefits of the HUF structure. In such situations, it can be challenging to manage and distribute assets fairly among family members, leading to additional legal and emotional complications.

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Ways to Reduce Tax Outgo with an HUF

• Rental Income from Property
  Rental income from property can be credited to the HUF's account instead of an individual’s account. This allows the income to be taxed under the HUF, taking advantage of separate tax slabs and exemptions.
• Business Income
  If the family business is registered under the HUF, profits generated can be taxed as HUF income. This allows the HUF to claim tax exemptions and deductions, reducing the overall tax burden.
• Remuneration to Karta and Members
  Remuneration paid to the Karta (head of the HUF) and other family members for their contributions to the HUF’s operations is an allowable deduction. This reduces the taxable income of the HUF while compensating members for their efforts.
• Loans to HUF Members
  The HUF can provide loans to its members for business expansion, capital investment, or personal use. These loans may or may not carry interest, depending on the HUF’s financial strategy. This can facilitate wealth creation while managing tax liabilities effectively.
• Family Settlement or Arrangement
  Family settlements or arrangements made to resolve disputes over property among HUF members are not considered transfers. This ensures they are exempt from gift tax, capital gains tax, or clubbing provisions. Such arrangements can help minimize or even eliminate tax liabilities while maintaining harmony in the family.

Each of these strategies leverages the unique tax benefits associated with HUFs, helping families optimize their tax outgo effectively.

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Can HUF hold assets in its name?

An Hindu Undivided Family (HUF) can hold assets in its own name. In fact, it's a distinct legal entity separate from its individual members. This means the property owned by the HUF doesn't belong to any single member but is collectively owned by all the members.

Here are some common types of assets an HUF can hold:

• Ancestral property
• Gifts received by the HUF
• Proceeds from the sale of joint family property
• Property acquired through a will
• Contributions made by HUF members to a common pool

It's important to remember that since all members have a right to the HUF's assets, selling them requires consent from everyone involved.

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Partition of HUF

A Hindu Undivided Family (HUF) can undergo a partition, which essentially divides the family's property and severs the joint family status. There are two main types of partitions in an HUF:

• Total Partition: This is a complete division of the HUF. All the coparceners (individuals with a share in the HUF property) receive their designated portions, and the HUF ceases to exist as a legal entity.
• Partial Partition: This is a more nuanced division. It can be:
  • Partial by Members: In this scenario, some members choose to separate from the HUF and take their share, while others remain together. The HUF continues to exist for the remaining members.
  • Partial by Property: Here, only some of the HUF's assets are divided among the coparceners. The remaining property continues to be held jointly by the HUF.

HUF Important Points to Consider

A Hindu Undivided Family (HUF) is required to file its return of income annually, considering all income earned in the HUF's name. However, the clubbing provisions under tax laws can hold the Karta liable for any income diverted to the HUF with the intent to evade taxes.

Contribution of Assets to HUF

Any asset contributed to an HUF is treated as a common asset, with the contributor renouncing ownership in favor of the HUF. Consequently, if the previous owner wishes to sell such an asset, it cannot be done without the unanimous consent of all HUF members.

Expanding Membership and Management Challenges

The addition of new members through birth or marriage further expands the HUF. Managing a large HUF can be challenging, particularly when maintaining accurate records of assets and funds contributed to or held by the HUF.

Partition and Dissolution

Shutting down an HUF is a complex process. Partition of an HUF cannot proceed unless all members agree to the division.

Female Karta and Taxation Implications

In the absence of a male member, a female member can become the Karta. However, the tax implications in such cases remain unclear and require further clarity in law.

Clubbing of Income and Wealth

• If the Karta or any member transfers property to the HUF without adequate consideration, the income from that property is clubbed with the transferor's income for taxation purposes.
• Any wealth brought by a woman from her maiden home is not taxable as HUF income. Instead, it is taxed as the individual income of the wealth owner.

HUF offers tax benefits by providing separate tax exemptions and deductions similar to those available to individuals. This can lead to significant tax savings for families, as income is divided among family members, potentially resulting in lower overall tax liability. To know more about the tax implications of HUF and CA assisted e filing income tax return, Book eCA Now!

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