The concept of having a joint family and joint businesses and assets still exists in India. However, having joint finances and assets can also become a point of strife between families. A common way to manage financial affairs of families more efficiently is forming an HUF (Hindu Undivided Family). As the names suggests, an HUF consists of a group of family members lineally descended from a common ancestor. Typically, the father or the eldest member of the family is the karta or the head of the HUF, while other family members are coparceners or members.
The karta manages the day-to-day affairs of the HUF, while children are coparceners in their father’s HUF. According to rules, once a daughter gets married, she becomes a member of her husband’s HUF, while continuing to be a coparcener of her father’s HUF.
People prefer having an HUF when the income from a business or property is for the whole family and not for just an individual such as income from ancestral property.
Remember that establishing an HUF is not limited only to Hindu families, but even to Jain, Buddhist and Sikh families. A female member, too, can be the karta of an HUF. In a landmark judgment on 22 December 2015, Justice Najmi Waziri of the Delhi high court said that the eldest female member of an HUF can also become its karta. The judgment brought clarity on the otherwise general belief that only a male member can become the karta of an HUF.
Apart from smoothening out the financial affairs of a family, an HUF also comes with the added advantage of giving tax benefit.
Under Section 2(31) of the Income-tax Act, 1961, an HUF is considered a “person" and, therefore, is treated as a separate entity for the purpose of tax assessment.
Families that own ancestral properties and businesses can obtain a separate Permanent Account Number (PAN) in the name of the HUF. Once a separate PAN is obtained, incomes earned from the assets and businesses owned by the HUF can be assessed separately, which will also bring down the family’s tax liability.
Let’s understand this through an example. Suppose an HUF consists of a husband, wife and their one minor child, and they own an ancestral property from which they earn an annual rent of ₹10 lakh. If a separate PAN has not been acquired for the HUF, this rental income will get clubbed with either the income of the husband or the wife, and will be taxed according to the slab rate applicable to them. If they fall under the highest tax bracket of 31.2%, they will have to pay a tax of nearly ₹2.18 lakh (31.2% of ₹7 lakh (after standard deduction of 30% from rental income of ₹10 lakh) on the rental income. However, in the case of an HUF, the tax liability will come down to ₹54,600. This is because since the HUF is treated as person, no tax will be levied on ₹2.5 lakh, the next ₹2.5 lakh will be taxed at 5.20% and the remaining ₹2 lakh at 20.8%).
An HUF is taxed on the same slab rates that are applicable to an individual income tax assessee. Also, deduction under various Sections of the Income-tax Act such as 80C, 80D, 80G is also available to an HUF. However, keep in mind that once the family income is assessed as an HUF, it will continue to be assessed as such in subsequent assessment years as well till partition is claimed by the coparceners of the HUF.