FAQs on HUF: Tax benefits, formation, and key rules explained

An HUF is recognized as a separate entity for taxation purposes, with its own PAN, allowing it to claim additional deductions and exemptions. (Image: Pexel)
An HUF is recognized as a separate entity for taxation purposes, with its own PAN, allowing it to claim additional deductions and exemptions. (Image: Pexel)

Summary

  • Confused about Hindu Undivided Family (HUF) units? This guide answers the most common questions about their tax advantages, formation, income types, and legal intricacies. Get expert insights on how to effectively manage your HUF for maximum tax savings and compliance.

A few weeks ago, when Mint Money discussed Hindu Undivided Family (HUFs) units, we received a flood of queries. To address the most common concerns, this article has compiled frequently asked questions regarding tax-saving instruments available to Hindu, Sikh, Jain, and Buddhist communities.

Tax experts Balwant Jain and Prakash Hegde address these queries, offering insights and highlighting differing perspectives where interpretations vary.

Read this | How can you save tax on mutual funds by forming a Hindu Undivided Family unit?

What are the tax benefits of forming an HUF?

An HUF is recognized as a separate entity for taxation purposes, with its own PAN, allowing it to claim additional deductions and exemptions.

How it works:

Consider a case where an individual (Person A) earns a taxable salary of ₹20 lakh and receives ₹7.5 lakh as rental income from an ancestral property. After availing of a 30% standard deduction on rental income ( ₹2.25 lakh) and a ₹1.5 lakh deduction under Section 80C, their taxable income amounts to ₹23.75 lakh, resulting in a tax liability of ₹5.46 lakh.

If the property were held under an HUF, separate deductions and exemptions would apply to the HUF's rental income, reducing the total tax liability to ₹3.82 lakh—a saving of ₹1.64 lakh.

In essence, creating an HUF doubles the tax benefits by splitting income into two separate taxable accounts. This principle can also apply to financial assets.

How to form an HUF?

An HUF is created by default and cannot be established through contracts or agreements. It requires at least two members, with varying opinions on when an HUF officially forms.

Common View: Marriage of a couple creates an HUF.

Alternative View: The birth of a child is necessary.

To open a bank account or obtain a PAN, the karta (head of the HUF) must provide an affidavit along with the names and addresses of the coparceners.

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How can a corpus be created or transferred to an HUF?

Transferring money or assets to an HUF involves careful consideration of two key aspects: the tax implications at the time of transfer and the treatment of income generated from the transferred assets.

When a member of an HUF, treated as a relative under tax laws, transfers an asset to the HUF, the transfer itself does not attract any tax liability. However, any income generated from the transferred asset or capital gains realized upon its sale is clubbed with the transferor’s income and taxed accordingly, despite the asset being held in the HUF’s name. This tax treatment arises due to the "clubbing provision" in the Income Tax Act.

Also read | Why you cannot complain to Sebi about unregistered investment advisors

Notably, if the income generated from the original asset is reinvested into a new asset, the subsequent income from that reinvestment is taxable in the hands of the HUF. This distinction allows the HUF to eventually claim taxation on income generated beyond the initial transfer.

If a non-member gifts an asset to an HUF, the gift is taxable if the total value of all gifts received by the HUF during the year exceeds ₹50,000. However, in such cases, the clubbing provision does not apply. This means any income or capital gains generated from the gifted asset are taxed in the hands of the HUF, not the donor.

Notably, even a close relative (e.g., a father or mother) is considered a non-member for this purpose unless they are part of the HUF.

Inheritance is the most tax-efficient method of building an HUF’s corpus. When an HUF receives assets through a will, the transfer is entirely tax-free, and the clubbing provision does not apply. This makes inheritance the most effective and widely preferred method for building an HUF’s corpus. Notably, any individual, not just a close relative, can leave assets for the HUF through a will.

What type of income can an HUF earn?

An HUF can earn income under various heads, including:

House property: Rental income from properties owned by the HUF.

Business: Profits from businesses conducted under the HUF's name.

Capital gains: Earnings from the sale of assets such as real estate or investments.

Income from other sources: This includes interest, dividends, and similar earnings.

However, an HUF cannot earn income from salaries or professions because these require individual effort, which cannot be attributed to an entity like an HUF. Similarly, freelance income is ineligible as it is considered personal effort income.

Can a member give an interest-free loan to an HUF for investment?

The views on this are divided:

Balwant Jain (Tax Expert): Jain states that interest-free loans to an HUF are not allowed under Section 60 of the Income Tax Act, 1961. If such a loan is given and subsequently invested by the HUF, any income generated from it will be taxed in the hands of the transferor.

Prakash Hegde (Chartered Accountant): Hegde contends that anyone, including a member, can lend money to an HUF as an interest-free loan. Income generated from the loaned amount cannot be clubbed with the lender’s income. Courts have supported this view.

However, tax authorities often scrutinize such arrangements and may treat them as a sham, attempting to club the income with the lender’s taxable income. This underscores the importance of proper documentation and legal compliance when engaging in such transactions.

How to close an HUF and address its complications?

Closing an HUF can be approached in two ways: partial partition or full partition.

Partial partition: In this scenario, a member may request to separate from the HUF while others wish to continue. However, partial partitions are not recognized under tax laws. For example, if a house is transferred to a departing member during a partial partition, the income generated from the property may still be taxed under the HUF, even if the property’s ownership changes.

Full partition: A full partition involves dividing all the HUF’s assets among its members, which dissolves the HUF entirely. This is the only type of partition acknowledged under tax laws.

Should you sell HUF property before or after partition?

Hedge said it is generally more beneficial to sell property after the partition. Here's why:

Section 54EC exemption: When you sell a property and invest the proceeds in capital gains bonds, you can claim a tax exemption of up to ₹50 lakh.

If the property is sold before the partition, the HUF as a single entity can claim only one exemption of ₹50 lakh.

If the property is partitioned first and then sold, each member can individually claim the ₹50 lakh exemption.

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(Grfx: Mint)

Other sections:

Section 54: Exempts capital gains from the sale of a residential property if the proceeds are reinvested in another residential property.

Section 54F: Applies when assets like mutual funds, stocks, or land are sold and a residential property is purchased. However, members who own more than one residential property are not eligible.

In many cases, HUFs may already own multiple properties, making them ineligible for exemptions under Section 54F. By partitioning the assets first, individual members can meet the eligibility criteria and claim these benefits separately.

Read this | How Hindu undivided families can maximize tax savings

For maximum tax efficiency, consider partitioning the HUF before selling the property.

Can HUF deny partition?

Both coparceners and members of an HUF hold rights in its property, but only coparceners can request a partition. Coparceners are individuals born or adopted into the family, such as a father, son, or daughter. In contrast, those who join the family through marriage, like a wife or mother, are members but not coparceners.

The karta, or head of the HUF, cannot deny a partition request. Once a coparcener demands partition, it is legally deemed to have occurred on that day, even if the actual division of assets happens later. Consent from all members, including non-coparceners, is required before selling any HUF property.

Also read | How taxes and fees add 7-12% to your property purchase cost

In cases where the HUF holds a single, indivisible asset, such as an apartment, the property might need to be sold to distribute the proceeds. Alternatively, the other members can buy out the share of the coparcener requesting the partition.

The right to partition is absolute for coparceners and cannot be overridden by the karta or other family members.

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