How does Hindu Undivided Family Act (HUFA) Allows You to Save Tax

The full-form of HUF is Hindu Undivided Family. Incorporating a family structure and pooling resources together to form a HUF can result in tax benefits for the participants. When you form a Hindu undivided family, you can include every one of your family members to avail the tax benefits of the HUF act. In this post, we are going to be discussing in detail about how does Hindu undivided family act (HUFA) allows you to save tax, what is HUF and more.

Did you know?

For tax purposes, HUF is considered a separate section of the society and therefore, it is taxed separately. A HUF is governed by the Hindu law board.

What is HUF?

As we’ve mentioned earlier, the HUF, in its entirety, is subject to a different tax regime than the individuals who make up its membership. A HUF is formed when Hindu families come together in order to form a federation. Buddhists, Jains, and Sikhs are among those who can also establish a HUF in addition to Hindus. 

The HUF has its own tax identification number and is responsible for completing a tax return on its behalf without the assistance of its partners.

Benefits of Forming a Hindu Undivided Family in Terms of Tax Savings

A HUF is a separate entity with both private and business owners and can be taxed in the hands of income tax authorities. There are many advantages you can avail in forming a HUF – 

• A HUF can start a business and receive profits from it.
• A HUF is a legal entity that can possess a corpus, cash or another capital asset. 
• Any personal funds transferred to the HUF will trigger clubbing provisions, meaning that the income from the HUF is treated as individual income. And therefore, it is taxable.
• When you or your family as a whole separate from a Hindu Undivided Family, you won’t get a larger portion of the assets you owned as a HUF. Instead, the opponent party will get more assets.
• The tax implications of forming a HUF vary between every state.

The HUF is taxed separately from its members, which can cause tax complications. However, the HUF can claim Section 80 deductions on its HUF income, and the individuals can claim these deductions separately. 

Also Read: Capital Gains Tax India– Definition, Types, Exemptions & Tax Saving

Possibilities to Save Money in the Long Term by Becoming a Member of A HUF

Being taxed separately from its members, the HUF can claim any deduction such as those granted under Section 80 or exemptions permitted under HUF account’s tax regulations.  Lets understand this with a clear example. If you and your spouse, together with your two children, decide to join a HUF, then both of you and the HUF is eligible to claim a Section 80C deduction on your federal income tax return. Families frequently use HUF as a means of availing a larger amount of tax benefits. Let’s go over this in greater detail.

What Kind of Taxation does the HUF Come Under?

The HUF has its tax identification number and produces a separate tax return from the rest of the society. Considering that it exists as a separate legal entity from its members, a joint Hindu family business can be founded in this way:

• Tax deductions under Section 80 of the Income Tax Act and other exemptions may be claimed by the HUF in its filing of annual income tax return.

• The HUF has the option of acquiring a life insurance policy for the members of the organisation.

• The HUF can pay its members if they make significant contributions to the organisation’s operation. Fortunately, this payroll expense can be deducted from the HUF’s gross revenue for tax purposes.

• A HUF, in contrast to an individual, is subject to the very same tax rates as an individual taxpayer.

Let us consider the following scenario to understand better on how a HUF is taxed. Mr Mahesh Sharma, upon the death of his father, decides to form a HUF with the participation of his spouse, sons, and daughters as participants. Since Mr Sharma was his parent’s only child, the assets he received were transferred to the Hindu Universal Family or to a religious organisation (HUF). Approximately ₹7.5 lakhs in rental revenue are generated by the property held by Mr Sharma, father of Mahesh Sharma, who passed away in 2007. Mahesh Sharma receives an additional 20 lakh in addition to his salary. This was possible due to the fact that his father owned many other businesses and the money earned is as a result of that. As seen in the chart below, Forming a HUF may enable Mr Sharma to save money on taxes.

The tax strategy allowed Mahesh Sharma to save ₹1,54,500 in taxes, which he used to fund his business. Section 80C of the Income Tax Act allows both the HUF and Mr Mahesh (and other members of the HUF) to claim a deduction for the amount spent on his business project. 

The HUF’s revenue may also be used to make investments, which will continue to be subject to taxation as long as he is in the HUF.

What Is the Procedure For Establishing a HUF?

• A single individual cannot constitute HUF; instead, it can only be established by a group of family members and individuals.
• In terms of marriage, a HUF is formed for the couple immediately.
• The HUF generally consists of a common ancestor and their lineal descendants, including their spouses and unmarried daughters.
• HUFs can be founded by Hindus, Buddhists, Jains and Sikhs.
• In addition to assets that have been given to them as gifts, bequeathed to them, or inherited from them, HUFs frequently own property acquired through the sale of joint family property and assets donated to a shared pool by members of the organisation.
• It is necessary to register a HUF as a legal entity in its own right once the government has approved its formation.
• A HUF should have a legal deed in place before it starts its operation. 
• Both information about the HUF’s members and information about its business must be included in the deed. 
• For the HUF to function appropriately, a PAN number must be obtained and a bank account in its name should be created.

Also Read: How To Save Income Tax on Income From Salary For Individuals

Drawbacks of Forming a HUF

Although a HUF appears to be the most beneficial solution for a family to save money on taxes, it does have certain drawbacks.

• Members have equal rights to the property: The primary disadvantage of forming a HUF is that its members have the same rights to the property owned by the HUF. It is not possible to sell the common property unless and until all members agree to do so in a written agreement. Any new family members, whether by birth or marriage, are automatically accepted as members of the HUF and are entitled to the same rights and advantages as existing members. A HUF can balloon to unmanageably large proportions in terms of its size.

• Partition: One of the most terrible aspects of beginning a HUF is the prospect of having to close it down. The only way to dissolve a HUF is through the process of dividing the common property equally among its members. To dissolve the HUF, all of its members must agree on the terms of dissolution before the process can begin. An asset allocation process known as a partition is a legal procedure in which assets are distributed among family members, resulting in numerous conflicts and a significant deal of legal aggravation.

• The shared family setup is getting increasingly outdated: The HUF is a separate taxable entity from the rest of the family, so the Income Tax Department has recognised it as such. When nuclear families are the norm in today’s society, the HUF is getting increasingly out of touch with reality. Several instances have come to light in which couples or families are fighting it out over shared household expenditures. Still, they neglect to explore the possibility of pooling their financial resources. Due to the rising number of divorces, the HUF is becoming less and less essential as a tax shelter.

• HUF will be evaluated indefinitely till the time of partition: If a HUF is established, you will be expected to continue to file its tax returns until the HUF is disbanded, unless an exception applies. If you want your claim for a division to be considered, you must submit it in writing to the assessing officer. The assessment officer who receives a written copy of this nature is required to investigate the claim after alerting the claim to all the HUF members.

1. Profits from the divided property are taxed according to the individual income of each member who receives them. 
2. It is important to note that if the member, their spouse and any children join a new HUF, all income from the property transferred from an earlier HUF is taxed in the hands of the new HUF rather than the previous HUF.

Conclusion

In the case of a HUF, all family members should be registered as a single legal entity to avoid confusion. This must be done carefully since the HUF tax burden will be lowered to a greater degree. Sections 80C and 80CCF of the Internal Revenue Code allow you to get tax exemption on your investments, if you are a member of a functional HUF. Individuals who do not have any assets, on the other hand, are not eligible for this extra deduction. As a result, if you have a large family, you might consider forming a HUF.

Follow Legal Tree for the latest updates, news blogs and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary and accounting