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Amit and Swati Shah work in the software industry and earn a decent income. This year, their chartered accountant suggested they create a separate Hindu Undivided Family (HUF) to help reduce their tax outgo.
HUF and related I-T provisions
Like the Shah's, many have heard about HUF as a tax planning tool but due to lack of awareness, have not been able to move forward. In simple words, HUF can be defined as a family devolving from a common male ancestor and consisting of wives and unmarried daughters bound by the fundamental principle of family relationship. The concept of HUF is applicable to Hindus and includes Buddhists, Jains and Sikhs.
Income Tax Act, 1961 has, under Section 2(31) defined "person" to include HUF and grants it a separate status under the Act. Similar to an individual, HUF enjoys slab-wise tax rates and a basic tax exemption upto Rs 2.5 lakh. Also, as per Section 56 of the Act, any sum of money/property received by the HUF from a members or receipt on occasion of marriage, under a will/inheritance, from local authority/trust, etc is not taxable in the hands of HUF.
Case study
Amit and Swati earn Rs 20 lakh and Rs 8 lakh respectively in annual salary. They have a daughter aged two years and an ancestral property from which they earn Rs 10 lakh rental income every year. Till now, the income is being shown in Amit's return every year. Also, recently, the Shah's held a function on their daughter's birthday and received gifts from relatives totalling Rs 2 lakh.
Now, let us consider two scenarios. In the first, we assume that the HUF is not in place and the rental income and cash gifts amounting to Rs 12 lakh is taxable in Amit's assessment. In the second scenario, this amount can be shown in HUF's, and not Amit's, return (see table). As a result of this approach, there is a significant tax saving of 20 per cent of the total tax outgo.
An HUF cannot be "created" as such and comes into existence as soon as there are two members in the family, one of whom is a male. This is the case even though there are no assets in the name of the HUF at that point. However, in practice, there are some procedures to follow to get the tax benefits:
1. Apply and obtain a separate PAN in name of the HUF in Form 49A.
2. Open a separate bank account for the HUF. This is not mandatory but highly advisable to keep on hand a clear trail of transactions in case of an income tax enquiry in future. For opening a bank account, PAN may be required along with a joint declaration from all members of the HUF.
3. Start putting in money/gifts received from your parents/in-laws/relatives and ancestral income to the HUF account. This can serve as a good starting point to build capital in the account. Remember to support transactions by a proper gift deed on stamp paper as documentary evidence.
When HUF's not a good idea
Tax planning using an HUF means that the income from all assets under one's control is effectively distributed in multiple tax entities to reduce one's overall tax liability. However, a family must carefully evaluate the benefits of creating an HUF. Successive and deliberate tax changes by the government with respect to the clubbing provision u/s 64(2) and de-recognition of partial partition u/s 171(9) in the I-T Act means that this tool now is largely useful only in case of families who have/expect high value ancestral properties in their portfolio.
The clubbing provision states that if a member of an HUF transfers self-acquired property to the HUF, income from that property will be taxable in his individual assessment and not in that of the HUF. Section 171 of the Act which deals with assessment after partition of HUF recognises only total partition and not partial partition.
In other cases, especially for middle income families, an HUF may create unneccessary hassles as the tax benefit will be small compared to the long list of procedural compliances like obtaining a separate PAN, maintaining a bank account, filing separate tax returns every year and a possible scrutiny by the tax authorities.
What to watch out for
* As regards vesting self-acquired property into the HUF, you must be aware that in case of a dispute or a claim for partition within the family, you will not be able to assert your right in individual capacity over the asset and will only have your share in the capacity of a member. So, if you have earmarked some assets for long term non-compromisable financial goal like retirement, it is not advisable to risk ownership by vesting it in HUF.
* Several courts have opined from time to time that the "intention" to gift to an HUF and not to any individual has to be explicitly clear. Hence, a properly drawn gift deed is a must. Also, the gifts should be genuine and reasonable amounts and not just book entries.
* Members should not put their personal funds in the HUF bank account
* A bequest of money/property to an HUF can also be done by a Will provided the Will clearly states that the bequest is in favour of the HUF.
* Non Resident Indians (NRI)/Persons of Indian Origin (PIO) can create an HUF if they are governed under the Hindu Law. The residential status of an HUF will be resident except where the management and control of its affairs is wholly outside India for the particular fiscal.
* A karta who is generally the senior most male member of the family has the right to sign all documents and take all decisions in the best interest of the HUF. However, a karta can delegate this power.
* An HUF continues to exist till a coparcener claims partition. Though it can be total or partial, the I-T Act does not recognise partial partition.
* By amendment in the Hindu Succession Act in 2005, a daughter has an equal status as a son in coparcenery of the HUF. So, in case of a partition of the HUF, the daughter will be entitled to the same share as that of the son.
* If an HUF is a partner in a firm, remuneration received by the Karta will not be construed as income of the HUF unless there is a something to suggest that remuneration is in the form of an interest on the funds invested by the HUF - Laxman Das Vs CIT [1982] 138 ITR 628 (All).
* In case of a death of sole male member succeded by his widow, the HUF does not cease to exist and will continue - CIT Vs. RM. AR. AR. Veerappa Chettiar [1970] 76 ITR467 (SC).
The writer is founder, Soham Financial Planners
