I am sure many of you must have wondered whether it is possible for you to have a Hindu Undivided Family (HUF) as a separate taxable entity to lower your income-tax liability, but could not go ahead because you were not clear as to what is an HUF and how one can go about it.

As the name itself suggests, an HUF is a family of Hindus. Therefore, you have to be a Hindu to be eligible to have an HUF. Even Buddhists, Jains and Sikhs are regarded as Hindus and accordingly can have HUFs.

Members of HUF

Shyamal Banerjee/Mint

Who can use it for tax purposes?

There needs to be at least two members, one of whom is a coparcener, to constitute a family under Hindu law, but for tax purposes, unless a family consists of at least two coparceners, it is not taxed as an HUF, but its income is taxed in the hands of the sole coparcener. Thus, normally a husband and wife would not be taxed as an HUF, except where the funds have been received by the husband on partition of a larger HUF (an HUF of his forefathers). However, today, a husband, wife and son or daughter would constitute an HUF for tax purposes. The HUF is already in existence, though it may not have any funds and therefore no income.

What is the benefit of HUF for tax purposes?

An HUF is regarded as a separate taxable entity, different from its members. The rates of tax applicable to an HUF are the same as those applicable to individuals—the slab rates of 10%, 20% and 30%. Therefore, if an HUF has income of 10 lakh, it would pay income-tax of 1.3 lakh, whereas if the same income were added to the income of the individual who is in the highest tax slab, he would have paid a tax of 30% on such income, which comes to 3 lakh. If the income is derived by the HUF, there is a tax saving of 1.7 lakh.

Is it so simple?If it is so simple, why are more people not filing separate returns for their HUFs showing such separate income and paying tax at lower rates? What you need to keep in mind is that tax laws do not permit you to divert your own income to the HUF. For instance, your salary income is taxable in your own hands and cannot be taxed as income of an HUF. Only the income attributable to funds invested of the HUF itself or the income from business carried on by an HUF is taxable as the income of HUF.

How does one build up funds of HUF?

If a member of the HUF converts his own personal savings into HUF funds, the clubbing provisions apply and there is no tax advantage. If the HUF does not have inherited funds, the only way it can build up its funds is out of its income, by receiving gifts from close relatives and friends or by receiving an inheritance under a will, where the HUF itself is a beneficiary. Funds received on inheritance from a parent who has expired without leaving a will or who has made you the beneficiary, would not be treated as HUF funds.

Again, here you need to keep in mind the provisions of income-tax, taxing gifts received from persons other than relatives. So far as an HUF is concerned, only a member of an HUF is regarded as a relative, and in the case of such gifts from relatives, the clubbing provisions apply. Therefore, effectively only gifts of up to 50,000 a year can be received by the HUF from persons other than members of the HUF, without such gifts being taxable. Of course, the basic exemption limit to the extent not utilized by other income would also be available and an HUF which has no income can receive gifts of up to 2.5 lakh a year without paying any tax on such gifts. It is essential that the gifts are genuine, and from close relatives and friends, or else you may end up paying tax at 30% of the value of such gifts received, they being treated as unexplained cash credits.

Given this, do consider whether it is possible for your HUF to build up its funds and income. Of course, there are various other issues which you need to keep in mind when you are building up the funds of an HUF. We will discuss these in a subsequent article.

Gautam Nayak is a chartered accountant.

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