What is HUF?

A Hindu Undivided Family consists of all males lineally descended from a common ancestor, their wives, daughters, and daughters-in-law. HUF can also be formed by Brahmo Samajist, Arya Samajist, Virashaiva, Lingayat, Prarthna Samajist, Jains, Sikhs, and Buddhist families.

There are two schools of law governing HUFs in India-Mitakshara and Dayabhaga and there are quite a few differences in the rights and obligations of HUF members in each of these schools. However, since the Dayabhaga school is largely confined to Bengal, we shall, in this article, only consider the provisions of the Mitakshara school, which are applicable to the rest of India.

Who can be members of HUF?

All the members in your family, including your wife, children, their wives and their children. While the male members are called coparceners, the females are referred to as members. The senior-most male member is called the Karta (manager), and a typical HUF consists of a Karta, his sons, grandsons, and great-grandsons (all of whom are coparceners), and their wives and unmarried daughters (all of whom are members).

What are the rights of HUF members?

The difference between a coparcener and a member is that a coparcener can demand partition of an HUF. This is by way of distribution of HUF property among the coparceners. While each coparcener would then be entitled to a share of the property, the members would be entitled to receive maintenance from the HUF.

The Karta generally manages the family property, which is regarded as the joint property of all the coparceners.

Are daughters coparceners?

After the amendment of the Hindu Succession Act, 1956 in the year 2005, effective from the 9th of September 2005, daughters, like the sons, become coparceners. Till the amendment, they were merely members of the family and did not form part of the coparcenary.

Who is responsible for managing an HUF?

The person who manages the affairs of the family is known as the Karta. Normally, the senior-most member of the family acts as Karta.

What is the benefit of creating HUF?

Under the Income tax law, an HUF is treated as an independent person (Separate legal entity) for tax purposes. It means, like you and I, it is a taxable entity and is subject to tax provisions in India. Therefore, like an individual taxpayer, it has all the benefits of Income Tax Slabs, Deductions u/s 80 and a majority of the tax provisions including exemptions which are otherwise only available to individuals.

So, if an individual is able to structure his taxable income or split his taxable income between his individual self and his HUF, he can claim double benefits for deductions and expenses in both capacities, thereby substantially reducing his overall tax liability. An individual can file two income tax returns, one in his individual capacity and second in the name of his HUF.

How do we capitalize an HUF?

  • Assets received on the partition of a larger HUF of which the coparcener was a member (like an HUF in which the coparcener's father or grandfather was the Karta).
  • Assets received as gifts by the HUF. Such gifts could be received from close relatives or close friends.
  • Assets bequeathed by a will that specifically favours the HUF.

What income is taxable as HUF income?

  • Any income that arises on the investment of HUF funds (like interest earned on loans given by an HUF) or on the utilization of HUF assets (like rent earned on renting out HUF property) would be regarded as HUF income. It is important that the income be earned using HUF funds or property only. If the income arises on account of the personal exertions of the Karta or any other member and not on investment of HUF funds, such income would generally be regarded as the individual income of the Karta or the member.
  • If an HUF contributes funds to the capital of a partnership firm, profit and interest received (from the firm) by a partner who represents the HUF is regarded as HUF income. This is because the income in the partner's hands arises on investment of the HUF's funds. However, if the Karta is also paid a salary by the firm for efforts put in by him, such funds would be regarded as the Karta's individual income. Investment profit can be regarded as the income of an HUF, particularly in cases where the HUF has paid margin money or deposits for such transactions.

What are Drawbacks of an HUF?

The assets of the individual will now become the assets of the HUF as a family unit comprising of the individual and all members of the family. All members of the family would have a right on the assets unlike if the assets were owned by an individual in his own name. Therefore, proper caution should be exercised before transferring assets in the name of the HUF.

An Individual cannot transfer his assets to the HUF since the Clubbing provisions u/s 64 (2) of the Income Tax Act, 1961 would apply and the income earned from the transferred asset would continue to be taxed in the hands of the transferee. Similarly, Partition of the HUF will have to be carefully thought through. The dissolution of an HUF will take place after the full partition of the assets of the HUF amongst its members. This may require execution of legal documentation to make it fool-proof.

How is HUF beneficial for tax planning?

Since an Individual and an HUF has similar benefits under the Income Tax Act, 1961, if a married individual can shift his income legally to his HUF, then he will have the benefit of much lower tax liability.

Similarly, several individuals are not able to utilize the exemptions and deductions available to them under provisions of Income Tax Act, 1961. For e.g. Section 80 C, 80 G, 80 D etc. Because of the sub-limits imposed on such deductions. For e.g. Maximum Deduction u/s 80 C is restricted to ₹ 1,50,000/-. Such individuals can route these payments through their HUF and thereby avail the benefit of deductions under these sections through their HUF. Let's try to understand this better with the help of an example.

Option A

Let's take the case of Mr Anurag, a married man having two children working in the Corporate Sector and earning a Salary of ₹20,00,000/- per year. His income includes income from investments of ₹10,00,000/-.

He also pays Life insurance Premium of ₹60,000/- for his family, PPF investment of ₹ 1,00,000/-. His company deducts PF of ₹1,50,000/- from his Salary. He also pays medical insurance premium for himself and his family of ₹20,000/-.

Gross Taxable Income from all sources 30,00,000 20,00,000 + 10,00,000
Deductions u/s 80c 1,50,000 Basic investments in PF, PPF and ELSS
Deductions under chapter VIA(80D,80E,80G etc) 20,000 Medical Insurance premium
Net Taxable Income from all sources 28,30,000 -
Total Tax Liability 6,81,345 -

Option B

Let's assume that Mr Adhiraj is able to legally shift his income from investments of ₹ 10,00,000/- to his HUF. He also pays Life Insurance premium of ₹ 60,000/- and PPF of ₹ 1,00,000/- in his name from his HUF. Let’s see his revised tax outflow in this scenario.

Gross Taxable Income from all sources 20,00,000 -
Deductions u/s 80c 1,50,000 Basic investments in PF, PPF and ELSS
Deductions under chapter VIA(80D,80E,80G etc) 20,000 Medical Insurance premium
Net Taxable Income from all sources 18,30,000 -
Total Tax Liability 3,72,345 -

The Tax liability of Mr Anurag's HUF will be as follows:

Gross Taxable Income from all sources 10,00,000 -
Deductions u/s 80c 1,50,000 Basic investments in PF, PPF and ELSS
Deductions under chapter VIA(80D,80E,80G etc) 0 -
Net Taxable Income from all sources 8,50,000 -
Total Tax Liability 84,975 -

Savings of Tax under option B is ₹2,24,025 per year (6,81,345 - 3,72,345 - 84,975).

Thus, from the above example, it is evident that, if Anurag is able to legally shift the incidence of taxable income from his individual capacity to his HUF and make payment of expenses on which he gets tax deductions from his HUF, he is able to save nearly ₹ 2,00,000/- every year.

HUF as a concept is very beneficial for someone in the highest tax slab. If you have any question on this, do reach out to me on [email protected].