Famous author Mark Twain once said, “A tax is a fine for doing well...” Given that the tax season is upon us, there can be no other opportune time to discuss one of the most important provisions under the Income Tax Act, 1961, that allows citizens to lower their tax liability — the Hindu Undivided Family (HUF).
It is a separate entity created by members of a family descended from common ancestors. Individuals belonging to an HUF can be categorised as coparceners and members.
Previously, only male members could be coparceners, but the government changed that in 2005 through the Hindu Succession (Amendment) Act, 2005. The head of an HUF is called the karta of the family and post January 2016, the government allowed for women, too, to become the karta of the family. The difference between the coparceners and members is that any of the coparceners can demand the partition of the HUF.
The main purpose of creating an HUF account is to lower one’s tax liability. The HUF’s income will not be taxed in the hands of any specific individual but as one whole family. The HUF will also thus have to have a separate permanent account number (PAN) card. Although Jain and Sikh families are not governed by the Hindu law, they are treated as HUF.
With the creation of an HUF account and the ensuing PAN card, a family can enjoy the benefits of Income Tax slab rates as charged to an individual. Additionally, similar to the tax deduction of Rs 1.5 lakh that you enjoy in your individual account under Section 80C, the HUF account too enjoys the same deduction limit; Section 80C instruments are PPF, LIC, ELSS, EPFO, etc.
Let’s now understand how an HUF account helps in taxation. Such a family can earn income from any source other than salary. It can be a rental income or income from consultancy, services, small business, etc. For instance, Priyank has a family of four including himself, his wife, son and daughter. Priyank earns Rs 20 lakh as salary and has ancestral property that earns him an annual rent of Rs 7.5 lakh.
If Priyank got the property from his father, while calculating his tax liability, both his income salary and rent income will be clubbed and taxed in his hands. Assuming that Priyank has not done any investments, he will be subject to a tax liability of Rs 6.56 lakh as he falls in the 30 per cent tax slab for assessment year 2018-19. If the ancestral property is transferred to an HUF of which Priyank is the karta, he will pay Rs 4.24 lakh as individual tax and the HUF will pay Rs 64,375 as tax.
So, in all, there will be a tax saving of Rs 1,67,375. By creating an HUF account, the tax liability on rent income was reduced by Priyank and the same could be invested for further gains.
Similarly, people who get additional income from consultancy or small businesses apart from their salary can create an HUF account.
How to create capital under HUF?
The Income Tax Act, 1961, allows gifts received from relatives of members of the HUF to be fully exempt of tax; all gifts here are pertaining to cash gifts. However, gifts received over Rs 50,000 in a financial year will attract tax if the person gifting is not a relative.
If a gift is received from a member of the HUF, then the income generated would be clubbed and taxed for the individual making the gift. However, if this income is invested in tax-free instruments, then the member making the gift will be exempt from tax burden as the income would be tax free.
Any ancestral property doesn’t belong to one individual, but to the entire family. So, any ancestral property can be transferred to the HUF as capital. It is advisable to take help of a chartered accountant to form the HUF capital in a legal manner so that taxes can be avoided.
This is beneficial for those who have rental income or multiple sources of income and individuals falling in higher tax brackets.
(Riken Mehta is an independent financial consultant with over 10 years of experience in the finance industry)