How Hindu undivided families can maximize tax savings

To create an HUF, the head of the family, or karta, needs to submit an affidavit to that effect to the income tax department, along with an application for PAN (permanent account number) for the new entity and details of the HUF members. Only couples who are married and have at least one child can set up an HUF for tax purposes. Here is how HUF works and how it can help you save taxes.

HUF structure

An HUF comprises the karta, coparceners and other members. The karta is authorized to sign cheques and carry out financial transactions on behalf of the HUF.

Coparceners are members who are born into the undivided family, for example, a father, son, and daughter. Members are outsiders who come into the family, notably a mother and wife, through marriage. “It is important to note that members brought into the family by virtue of marriage can’t be coparceners. At the same time, an adopted child can be a coparcener," says Balwant Jain, Mumbai-based tax and investment expert.

While both coparceners and members of the HUF have rights in property of this entity, only coparceners have the right to demand partition of the HUF. “All members have rights, but not necessarily in the same proportion. For example, if the son dies, his share would not directly go to his wife, but get proportionately divided among all members of the HUF," Jain points out.

Saving on taxes

An HUF is treated as a separate individual for taxation purpose and will have its own PAN number. To avail the additional tax exemptions and deductions, the HUF needs to show its income—be it from business, property, capital gains or other sources. Initial capital or funding for HUF can come from gift or loan from a non-related party or property inherited through a will.

Salaried individuals can take advantage of the additional exemptions and deduction limits through HUF on business income, but the business should originally be owned by the HUF for taxation benefit. If the business is transferred by an HUF member without appropriate consideration or given as a gift, the income from the business will still be taxed in the hands of the individual member.

“HUF gets almost all the benefits that an individual tax payer gets whether it is the basic exemption limit of ₹2.5 lakh, up to ₹1.5 lakh deduction under section 80C, deduction under section 80D for payment of medical insurance premium and provision of presumptive taxation," says Nitesh Buddhadev, Mumbai-based chartered accountant and founder of Nimit Consultancy.

Income from inherited property, if it is in the name of the HUF, can also help the individual to save on taxes. However, it is important that the property is clearly bequeathed to the HUF in a will.

Rental income from such HUF property will be taxed as per income tax slab of the entity, after availing the various exemptions and deductions. For example, individual A with a salary income of ₹20 lakh inherits property in his own name. He receives rental income of ₹7.5 lakh from the property. After availing standard deduction of 30% (- ₹2.25 lakh) and deduction under section 80C (- ₹1.5 lakh), his net taxable income comes to ₹23.25 lakh, translating into tax liability of ₹5.30 lakh.

Individual B is part of an HUF, which inherits a property through a will. Now, he can separately take exemptions and deductions on his own salary income of ₹20 lakh and separate deductions on the ₹7.5 lakh rental income from the HUF property. As a result, his total tax liability works out to ₹3.66 lakh. Individual B is able to save ₹1.57 lakh more compared to individual A, who didn’t have any HUF. “We often tell our clients to keep an HUF ready, as it can help them when there is an inheritance," Buddhadev says.

Other benefits

“Individuals often end up exhausting their section 80C limit of ₹1.5 lakh. If they have an HUF, it can make payments such as life insurance premium on behalf of its members and can claim deduction under section 80C," says Jain. Even with section 80D, if the limit is exhausted by the individual, payments can be made by the HUF towards premium of medical insurance of the member and claim the premium amount as deduction.

For taxation purposes, if an individual has multiple properties, any two can be considered as self-occupied (where the taxation is nil) and the remaining are considered as rented out. These properties are taxed accordingly. Even if these properties are not actually on rent, a market rent is considered and such income is taxed. However, as HUF is a separate individual entity, two additional properties can be considered as self-occupied and thus tax liability can be cut significantly.

Section 54F allows an individual to get full exemption on gains from any long term capital asset, if sale proceeds are reinvested in a residential house property that is held for at least three years. However, if the taxpayer already has more than one residential property, then he or she can’t claim the exemption. But, if the second property is an HUF property, the restriction is no longer applicable.