It was a late afternoon at our hospital today, my colleague Dr.Ravi was searching for something on the internet. When I enquired, he told that he was to shortly receive some inheritance from his grandfather and some distant relative had suggested him to form a HUF to save on tax, however, he was totally lost as he did not know the ABC of this animal known as HUF. Smiling within myself, I suggested to him that we should discuss it over a hot cuppa& so we headed for a cup of tea.
The joint family system forms the base of our Indian culture. The informal personal financial planning that Indian families do almost always involves a consideration of leaving “something” for the children and grandchildren. So, what is a HUF? It stands for “Hindu Undivided Family”. In simple words, it means a family devolving from a common male ancestor and includes wives and unmarried daughters.
Some important points to note on HUF are as follows:
It is a misconception that HUF is meant only for Hindus. Apart from Hindus, it also extends to Jains, Buddhists, and Sikhs.
A Karta who is generally the senior most male member of the family has the right to sign all documents & take all decisions in the best interests of HUF.
A will can also bequeath assets to the HUF if it is specifically mentioned in the will.
An NRI can also create a HUF and it is not limited to resident Indians only. However, the practical aspects and convenience of opening bank account, getting PAN, etc. sitting outside India have to be evaluated.
Following are some of the pertinent tax provisions on HUF:
Section 2 (31) of the Act recognizes “Hindu Undivided Family” as a separate unit of taxation, like an individual or a company. Being a separate unit, it gets a separate basic exemption limit of Rs. 2,50,000 and deductions u/s 80 CCC while filing the tax return.
As per Section 56, if a HUF receives any money/ property/gold from its members, it is not taxable in the hands of HUF.
Section 64(2) provides for clubbing of income on transfer of self-acquired property to HUF without adequate consideration, So if there is a transfer of self-acquired property it should be with adequate consideration.
In the case of partition, Section 171 requires Assessing Officer to conduct a thorough inquiry on the same. Also, the partial partition is no more recognized.
The simple idea of reducing tax liability by creating HUF is to shift a portion of income (from the inherited property) to a separate entity & claim the available basic exemption limits& reduced tax slabs under the Act.
Let us understand with the help of Dr.Ravi’s example. Suppose Dr.Ravi earns Rs. 15 lacs per annum & receive property as inheritance, which generates a rental income of Rs. 10 lacs a year. Now, if Dr.Ravi does not divert this rental income to the HUF, he’ll be taxed additionally @30.90% on this Rs. 10 Lacs. But if he does so, he’ll save a good amount of tax & let’s see how.
Case A: No HUF in place
Case B: Inherited property forms part of HUF
Now that Dr.Ravi is clear on the tax benefit of HUF, I tried to explain how to create one. As per Hindu law, HUF comes into existence as soon as there are two or more members in the family, one of them being a male member. However, certain minimum documentation steps need to be taken to “create” the HUF as a separate entity in the eyes of the income tax authorities as follows:
1. Create a “HUF deed” on stamp paper which recognizes the HUF, the Karta, its members and any property belonging or being merged into the HUF. If needed, take help of a CA or a lawyer.
2. Open a bank account in the name of the HUF.
3. Apply for a PAN for the HUF.
That’s it, you’re done! Once you’ve created a HUF, income from HUF property should be credited in HUF bank account & separate tax return of HUF should be filed every year. Any gifts, inheritances, etc. received should be made part of the HUF with a clear record of the donor and date of receipt.
While a tax saving every year can look very appealing, I cautioned Ravi to keep the following points in mind before taking the leap:
Given that many people use HUF route to escape normal incomes from tax, the IT department watches HUF transactions with extra skepticism. Hence, never use HUF as a tax evasion mechanism as it can have penal consequences.
Before vesting personal property into HUF, think ten times. This is because once you vest the property in HUF, you lose your individual right over it. In case of a dispute between family members, later on, you’ll not be able to reclaim it.
Members should not mix personal funds with HUF funds. Each entry in the HUF bank account should be supported by proper documentation.
HUF in a relatively less known way to reduce tax liability on income arising from inherited property. Tax changes like clubbing of income & de-recognition of partial partition have ensured that people cannot use it as a conduit to evade tax. As for Dr.Ravi, by the time we closed our discussion, I could sense a great deal of relief and clarity on his face now that he know’s how to go about the whole thing towards creating a HUF and using it to reduce his tax liability.
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