How to reduce tax liability through HUF? In this article we will discuss how to reduce the Tax Liability using HUF. As it is a separate legal entity in the eyes of Income Tax Act.
Formation of a HUF: Typically, a HUF is automatically created. As the name suggests, a HUF means a family of Hindus. However, under the Indian tax law, persons belonging to the Jain and Sikh religion can also form HUFs. The existence of a HUF requires at least two members of a family, of which at least one should be male. A HUF can also consist of the male members and female members, being their wives and unmarried daughters. Once a member of a HUF receives any ancestral property from any ancestor three generations above him, a HUF is automatically created. For example, if a married Hindu male person receives any ancestral property from his great grandfather, that property will be automatically regarded as his HUF’s property. Another way to form a HUF is by receiving an asset or property by way of gift from a lineal ascendant with a specific instruction by the donor that the same is being gifted to the HUF. Although generally, a HUF always exists in a Hindu family, from a tax point of view, it is created only when it receives assets or any property or is engaged in any commercial activity. A PAN card may be issued by the Income-tax Department in the name of a HUF and an account gets created for filing of tax returns.
It is a Separate Legal entity: HUF is a separate legal entity in the eyes of Income Tax Act. So, for HUF we have to file separate Income Tax return as we file in case of an individual. Basic exemption limit for HUF and Individuals are same. HUF can also claim all the deductions and exemptions like Individuals. Members of HUF can make investment in different areas which are eligible for 80C deduction and get benefits of Sec 80C additionally.
Deductions & Exemptions: Deductions of Section 80 and exemptions of Sec. 10 of Income Tax Act are available to HUF also.
What a HUF is eligible to do?
HUF Can be a proprietor of any firm: HUF can be a proprietor of a firm. That means anybody can start a firm in which HUF is the proprietor and other members along with Karta are running that firm. Karta and other members of HUF may become employees of the firm in which HUF is proprietor and may earn salary income from the firm. By this, the income can be split between HUF and the members. A separate and a different name can also be made for the firm in which HUF is the proprietor.
HUF can buy a Property also: HUF can buy a property and receive rental income. So individuals can buy a property in the name of HUF and receive rental income through it in HUF. By this, they can shift the burden from individual to HUF for rental income.
HUF can claim benefits of section 24 of Income Tax Act,1961: In case when HUF owns a property in his name, it can claim benefit u/s 24 (a) of Income Tax Act, i.e. Deduction of 30% from the rental income.
HUF can hold one self occupied property and claim benefit of Section 24(b): Under Income Tax Act, an individual can keep one residential premises as a self occupied property but if he purchases another residential premises then even though that premises is not rented and he is not receiving any rent from that, an amount equal to notional rent will be calculated and added in his income under the head income from other sources. For example if Mr.A possesses two houses in his own name and none of them is rented. Any one house at his choice can be treated self occupies and for other house a value equal to notional rent will be calculated and added in his total income. Here Mr.A can plan his affairs in such a way that another house can be bought in the name of Mrs. A from her own income and in such case she can also posses one more self occupied property. So even through husband and wife both are living in same house, for income tax purpose they can posses two different houses as self occupied for income tax purpose and nothing will be taxed as notional rent . But one step ahead from this situation, if they want to possess third house then in that case notional rent will be calculated and added in the income of owner. Now if in above case if Mr. A and Mrs. A plan their financial affairs in such a manner that they buy third house in the ownership of Mr. A (HUF), then in such case third property will also become self occupied property and notional rent will not be added in the income of Mr. A, Mrs. A or Mr. A (HUF) only if it is actually not given on rent. In this case the third house is also considered self occupied even though it is vacant and family is not living in that house. In above case, HUF can also take a home loan for property and claim benefit of deduction of interest paid on home loan up to Rs. 2 Lakhs from income of HUF under section 24(b) of the income tax act.
HUF can invest in Securities: HUF can open a Demat account in its name and invest in shares and also receive dividend income as well as capital gains. It can also invest in Mutual funds and fixed deposit or any other securities. But as individuals, HUF cannot open PPF account.
HUF can become a Partner in a Partnership Firm: HUF can become partner in a partnership firm. It can receive interest on capital, but cannot receive salary as a working partner, But HUF can receive share in profit from Partnership Firm which is exempted from tax.
HUF can give Loan: HUF can give loan to any and receive interest for the same. So if you need some money for the purpose of using it in your business or profession, say for buying a land or building or anything related to your business or profession and you are taking loan from bank or any other agency and if you have liquid corpus with your HUF, you can plan to take loan from HUF and pay interest to HUF. This way you will be getting deduction of interest from your income from Business or Profession where your tax bracket may be as high as 30% and on the other hand it becomes income of the HUF where your tax bracket may be as low as 0% or 10% depending on other income in the HUF head.
HUF can take Loans: HUF can take Loans from any. The loan taken can be invested in any asset to generate further income and the income which is generated from that asset will become income of HUF and will be taxed in the return of HUF income. If an Individual has corpus in his individual file and that is invested in any asset in individual name then income from that asset will be taxed under the income of that individual but if that individual transfers that corpus to his own HUF file in the form of loan and then invest in any asset like fixed deposits, property or any other kind of asset then income generated in the form of interest or rent or any other form will not be clubbed in the income of an individual.
HUF can receive Inherited Assets: This is one of the very good tax planning points. Whatever inheritance is received in HUF is free from Tax and any subsequent income from such assets will be considered income of HUF and will not be considered income of individual. So in such case one can plan his inheritance to be received in such a way that he can receive it in HUF and in such case subsequent income from such inherited assets will become income of HUF.
HUF can receive Gifts
Gift from Relatives: As per section 56(2)(vi) of Income Tax Act any sum received by HUF in Cash or in kind, exceeding Rs.50,000/- in a financial year without any consideration from anyone other than relatives is taxable. But if your HUF doesn’t have any other income and it receives a gift of Rs.250000 from a person other than relatives(members) it is taxable but as it is up to basic exemption limit of Rs.250000 it will become tax free and there will be not tax liability.
Note : For HUF, relatives are the members of HUF
Gifts given to members and others by HUF : Gifts given to members and others by HUF will be taxable if exceeds Rs.50000 in a financial year in the hands of person who receives the gift.
What a HUF can't do?
HUF cannot receive salary Income : HUF cannot receive salary income.
HUF cannot open PPF Account : HUF can’t open PPF account.
HUF cannot run any Profession : Anyone can't run a professional practice in the name of the HUF. Every profession requires an academic qualification and professional expertise in a particular area. HUF cannot have that academic qualification or professional expertise so it cannot run a profession.
Clubbing of Income: Income from property (movable or immovable) converted from members to HUF in the form of Gift will be clubbed in the income of Individual. So if any member gifts something to HUF then in that case gift is exempted income for HUF but any income generated from that gift in the form of interest, rent or any other form will be clubbed in the income of member of HUF who gifted the original asset. In this case even after partition of HUF, if spouse of such individual member who gifted property to HUF derives some income from such gifted property then that will be clubbed in the income of that individual member. But if in the above case the member has given loan to HUF and then that money is invested in any asset and subsequently some income is generated from that income. In that case income will not be clubbed in the income of individual member even though the loan is interest free loan.
Effective tax planning through HUF: An important benefit of creation of HUF is that any income earned by an individual in his capacity as member of HUF is not taxable in his individual capacity as it is already taxed in the hands of the HUF. A HUF, being eligible for all the exemptions and deductions as are available to an individual, it results in considerable tax savings as the total personal income of an individual, who is a member of a HUF is divided into his personal capacity and in the hands of the HUF. Joint assets or properties under inheritance for the entire family can be gifted to the HUF instead of gifting to individual members of the family. This can result in tax savings as there is no gift tax or inheritance tax and clubbing of income provisions will also not apply. Similarly, a Karta of a HUF can give, by way of gifts, certain amounts or assets out of HUF properties, to its members over a period of time to gradually build assets in their names. A HUF can also build its capital by way of borrowings from non-members and the income so earned from investments of the capital will only be HUF income. Individual members may also transfer their personal funds in a HUF for the purpose of investment in tax free instruments. Income thus earned from these instruments will be tax free and cannot be clubbed with the individual’s personal income. Such income, if it is reinvested in instruments, income of which is subject to tax, will also not be clubbed as only the income earned from transferred amounts is clubbed.
Conclusion: To conclude with the HUF. HUF is a good tax planning tool which is generally under-utilized by most of the people and therefore everyone should focus upon it. When you are planning structure of your business or profession or income from any other sources or house property, you should also keep taxation in mind and try to involve HUF in such a manner that it splits your income either from business income or from income from other sources.
The author is a CA in practice and can also be reached at firstname.lastname@example.org