How to save more tax by Creating a HUF?

Once, our venerable Finance Minister, Mr. M Chidambaram, has said, 'Left to God, even he will not like to pay Income Tax'. Though as a responsible citizen of our country, we should pay our income taxes on time and should not avoid paying it.

However, if the Income Tax Act, 1961 provides legal opportunities to save Income tax, it will not be prudent if you are not taking benefits of such provisions. HUF is an entity, which has been given certain exemptions, quite similar to an Individual by the IT Act. If you are a born Hindu or a Sikh or a Buddhist or a Jain, you can take benefit of these provisions, and if possible you should take it.

What is a HUF?

The Income Tax Act 1961 provides that a HUF (Hindu Undivided Family) is separate unit like an individual and is too assessed accordingly. A HUF can claim tax benefits under the income tax act as Wealth tax act.

A HUF is eligible for those exemptions that are available to a resident Indian who is not a senior citizen. It can own property and also have its own business. 

Who all are included in the HUF? 

The HUF includes those persons who, by birth, acquire an interest in some joint family property. It also includes all lineal descendants of these persons, and their wives, and children, both sons and daughters. Even married daughters can remain a part of the HUF, while being a member of her spouse's family HUF. 

What are the Income Tax Benefits in forming a HUF?

To understand the income tax benefits (we are not discussing the wealth tax benefits, as they too are available) additionally available by forming a HUF, let us take an example of a family, which is now common, the nuclear family.

Naresh is married to Priya and have two minor children, Jaya (daughter) and Bhargava (son). Naresh's annual income is Rs10, 00, 000 and Priya Rs10, 00, 000. Naresh has inherited an ancestral property, an apartment, which is on rent (annually Rs3, 00,000).

If Naresh forms a HUF, with him the Karta (head of the HUF), his children will be called coparceners and his wife will be a member. The first benefit Naresh, will have that the rent income of Rs3, 00, 000 which was hitherto assessed as part of his income and now be carved out and shown as HUF income, and the HUF will be assessed separately as another entity and will have the benefit of the exemptions of IT Act similar to those received by Naresh.

This will lead to substantial reduction of Income tax being hitherto paid by Naresh and the HUF will pay a much smaller amount of Income tax on this income of Rs3,00,000/- after enjoying the exemptions available. Also, the gifts received by the coparceners/member (beyond the exemption limit) can be shown as received by the HUF, thereby reducing the income tax burden of both Naresh and Priya.

Now, you may invest the HUF income in LIC policies, PPF accounts, ELSS instruments in the name of Karta, coparceners or member of the HUF and it will get the income tax deductions under Section 80C.

How to form a HUF?

The following steps are required to form a HUF:

1. Open a bank account in the name of Hindu Undivided family titled 'Naresh HUF' with a rubber stamp, ID Proof, residence proof and the proof of the members of the family of HUF.
2. The rubber stamp should be rectangular carrying the name of the HUF and that of the Karta
3. Then apply for PAN (Permanent Account Number) from the income tax authorities.
4. Transfer the rent income received from the ancestral property along with the excess gift amount received by the HUF members (Karta, coparceners and members)

Disadvantages of HUF

Though a significant amount of tax can be saved by forming a HUF, there are few disadvantages of HUF which should be taken into consideration. Whenever an asset is transferred to HUF it remains with it. Only when the coparceners will demand a partition of HUF, the property can be shared by the coparceners.

HUF property cannot be mentioned in the WILL. In case of Naresh HUF, the ancestral property transferred to HUF will remain part of HUF and Naresh later cannot transfer to his wife or son or daughter. Of course after his death, his son will become the Karta, but other members will enjoy the benefits and income of the HUF.

Who should actually form a HUF?

HUF will be a good option for persons who have sufficient income and savings and who also have some ancestral property too (which could be treated as family assets for HUF). Before forming a HUF one should calculate the tax benefits clearly and then take a calculated decision.

It is advisable to hire a financial advisor, well versed in forming HUF and who will be able to give the pros and cons so that an informed decision can be taken about formation of HUF.

The author is Ramalingam K, CFP CM is the Chief Financial Planner at holisticinvestment.in, a leading Financial Planning and Wealth Management company.