how to use huf as a tax planning tool

7/28/2019 How to Use HUF as a Tax Planning Tool

1/10

How to use HUF as a tax planning tool

A tax professional is the last person you would expect to dish out matrimonial advice, but

Delhi-based chartered accountant Mahesh Agarwal often tells his bachelor clients to

tie the knot. "If they are paying too much tax and all possible deductions have been

availed of, the only way to bring down the tax liability is by starting a Hindu Undivided

Family (HUF). However, they can do so only after they marry," he says.

Though tax planning must figure in the list of 10 whackiest reasons to say 'I do', there is

no doubt about the usefulness of the HUF as a tax planning tool. The taxman treats the

HUF as another entity, which is entitled to the same exemptions as any other individual

taxpayer and enjoys the same deductions as you and I. This effectively gives the karta

an additional basic tax exemption of 1.8 lakh per year, an additional tax deduction under

Sections 80C, 80CCF and 80D, along with the benefit of lower tax slabs.

The enormous tax savings from this arrangement are what led Suresh Bohra to set up

an HUF in 1995. It helps this Delhi-based stocks and commodities broker save close to

86,000 a year in taxes. "As the karta of the HUF, I get a combined basic exemption of

3.6 lakh a year as well as a savings limit of 2.4 lakh a year under Section 80C and

80CCF," he says.

Bohra isn't alone. Lakhs of taxpayers, including salaried professionals, small

businessmen, even retirees, use HUFs to save tax. You too can avail of this benefit

provided you fulfil the conditions and complete the legal formalities laid down for anHUF.

Who can form HUF?

Any Hindu, Sikh, Jain or Buddhist man can form an HUF, provided he is married. In fact,

an HUF is automatically constituted when a couple exchanges wedding vows. Still, there

are a few simple formalities to be completed for the HUF to function as a legal entity

(see graphic).

The first step is to form a corpus for the HUF. This can be any capital asset (property,gold, jewellery, securities, deposits) or cash. This is not as easy as it may sound. You

can't transfer just any asset to your family 'hotchpot'. Any personal funds or property

given by an individual to the HUF will lead to clubbing provisions under Section 64 (2) of

the Income Tax Act. This means the income from these assets will be treated as that of

the individual, thus defeating the very purpose for which the HUF was established.


2/10

A husband and wife can form an HUF but a wife can only be a member, not a co-

parcener. Therefore, the HUF income will not be assessed separately. A member has

equal rights but only a co-parcener can demand the partition of the HUF. "Only the birth

of a child will give the unit the status of an HUF for tax purposes," says chartered

accountant and legal expert Rakesh Gupta.

The HUF can be formed with money received as gifts from relatives. But there's again a

tax implication here. While there is no tax on gifts received by an individual from

specified blood relatives, the HUF does not enjoy this exemption. "The HUF is not an

individual, so it has no relatives. Any money it gets will be treated as a gift from a

stranger. If the value of the assets received as gifts in a year exceeds 50,000, it will be

deemed as income of the HUF and taxed accordingly," says Rakesh Gupta.

Even so, an HUF can safely receive gifts of up to 1.8 lakh in a year without incurring any

tax liability because of the basic exemption available to it. In fact, if the HUF invests 1.2

lakh in specified tax-saving instruments under Section 80C and 80CCF, it can receiveassets worth up to 3 lakh a year without having to pay a paisa as tax. The best way to

avoid the tax tangle is to form the HUF corpus with assets received as part of a will.


3/10

But here too there are certain conditions to be met. If the property is inherited by the

individual, transferring it to the HUF will again lead to clubbing. "A person can give

property and other assets to his son's HUF but it should be clearly specified that the

asset is for setting up the HUF," says Mukesh Goel, director, Mukesh Raj & Company.

One can also start the HUF with funds received on the dissolution (or full partition) of a

larger HUF. If the karta wants to divide the HUF property between the co-parceners, he

can transfer the fund to a newly formed HUF. If the ancestral property is sold, the

proceeds received can also be transferred to the HUF.

Joining the HUF

There's no need to fill an application form or submit KYC documents for joining an HUF.

All lineal descendants of the karta, their spouses and children automatically become

members of his family. Wives join the HUF as members, while children join on birth ascoparceners. "Even the unborn child of a member or co-parcener has an equal share in

the HUF," points out Goel.

Till a few years ago, there was a gender bias in the HUF rules because females did not

have an equal share in the ancestral property. A daughter ceased to be a member in the

HUF after her marriage. This changed in 2005 when the Hindu Succession Act was

amended to give equal rights to daughters even after they were married. "The 2005

amendment was a watershed for female rights," beams chartered accountant Minal

Agarwal.

Indeed, the 2005 amendment has changed the equation in favour of women, making

them more equal than men. Married women now have rights in two HUFs-their father's

as a co-parcener and their husband's as a member. However, they cannot start an HUF

on their own. In case, a kartadoes not have male heirs, the HUF property will have to be

partitioned among his daughters. Experts say it is best to write a will to this effect to

avoid disputes.

Padam Chand Gupta has already willed his HUF property to his two daughters. "Both of

them were against me writing the will, but I didn't want to leave anything to chance,"

says the octogenarian. Gupta's wife Kamlesh Rani is a co-parcener in her father's HUF.

However, while the Mitakshara system, which is followed in most parts of the country,

has accepted the change, the Dayabhagaschool, which governs the HUFs in West

Bengal and Assam, continues with the bias.

Under the Dayabhagasystem, the father is the sole owner of the joint family property. No

other member can enforce the partition of the HUF as long as he is alive. However, the
http://economictimes.indiatimes.com/personal-finance/tax-savers/tax-news/How-to-use-HUF-for-as-a-tax-planning-tool/articleshow/8643829.cms#write


4/10

Mitakshara law stipulates that the property belongs to the HUF, not to an individual. It

can, therefore, be partitioned even during the lifetime of the karta. Income and tax of

HUF

There are five basic heads of income, including salary, capital gains, rent, profit from

business, and income from other sources. Except for salary, the HUF can earn from all

of these. It can invest the initial corpus as well as the gifts received in subsequent years

to earn capital gains. Ancestral property can be let out to earn rental income. It can also

start a business and earn profit from it. Interest and royalty incomes are categorised as

other sources.

The karta will have to maintain the books of accounts of the HUF and file tax returns on

its behalf. The date of filing tax returns and the tax rate are no different from that of

individual taxpayers. He also needs to invest to save tax under Section 80C and

80CCF.

Through intelligent planning, an individual can shift some of the taxinefficient

investments to the HUF hotchpot so that the tax burden is lowered. Given the intricacies

involved, it is best to take the help of a professional. This is also because the taxman

looks at HUF tax returns with a degree of scepticism. "The income pattern of an HUF is

often questioned by income tax officers," says Bohra. The general belief is that the HUF

has been formed to evade tax and that its accounts have been fudged.

However, if your chartered accountant is good, he can help you cross these hurdleswithout putting you on the wrong side of the law or inviting a notice from the tax

department. "One must do a cost-benefit analysis. If by paying a fee of 8,000-10,000 tothe chartered accountant you can save 1 lakh in tax, it would be money well spent," saysGoel.

Smart strategies

Insure the family's health: The tax savings apart, the HUF arrangement can be used tooptimise the benefits on other fronts. Take health insurance. If there are enough peoplein the HUF (say 20-25), a karta can get a group health insurance cover at a lower pricethan that of an ordinary plan. Some recent innovations by insurance companies mayalso prove useful.

The Family First plan from Max Bupa Health Insurance Max Bupa Health Insurancecovers not just an individual and his family but even extended families including 13relationships. This policy is eminently suitable for HUFs because there is no upper limiton the number of people it can cover. In case the proposer (the kartaof the HUF) dies, anew proposer can take his place.

The plan offers a family floater cover of up to 15 lakh and the premium paid for thehealth insurance is fully deductible under Section 80D. This will help bring down thetaxable income of the HUF while offering insurance cover for the entire family.


5/10

Pay kartafor services: If the karta does not have a high income, the HUF can pay him asalary for his services. This salary will be taxed as his income and will be fully deductiblefrom the HUF income.

But experts warn that this should be a reasonable amount and should be commensurate

with the karta's skills, the time taken for HUF work and the nature of the business it isengaged in. "If the income tax authorities feel that this is being done to gain a taxarbitrage, they might disallow the expense," says Agarwal.

Use HUF income for expenses: The income earned by the HUF can be used for thehousehold expenses of the family. This will not only prevent the HUF kitty from bloating,but also allow individual co-parceners to use their own incomes optimally. For instance,a co-parcener can take a larger home loan to reduce his personal tax liability becausethe HUF income is enough to take care of his living expenses.

Tax officials can seek an explanation if a taxpayer does not withdraw from his bankaccount too often. It is an indication that the person has income from other sources as

well. However, if he is a co-parcener in the HUF, the taxpayers will be able to explainwhy the salary flowing into his bank account has not been withdrawn for months.

Distribute income to co-parceners: The karta can gift money to the coparceners from theincome earned by the HUF. This income is tax-free in the hands of the co-parceners. Inthis manner, a person with a high income will be able to get tax-free income.

Give loan for business: The HUF can also give loans to the karta or coparceners forsetting up a business. The HUF can charge interest on the loan. Interest paid on anybusiness loan is fully deductible. Therefore, for the borrower, it will be like taking moneyfrom one pocket and putting it in another and getting tax deduction on the interest.TheHUF can also give loans to the karta or co-parceners for setting up a business.

A caveat is in order here. If the coparcener borrows money to start the same business inwhich the HUF is engaged, the tax authorities may raise an objection. It will be seen asan attempt to evade tax. There have been cases where income from businesses startedby coparceners after borrowing funds from the HUF have been treated as HUF income.

Should you go for HUF?

The HUF arrangement especially suits taxpayers who also have income from ancestralproperty and expect to inherit financial assets. Such taxpayers will be able to divert theinheritance to the HUF, thus preventing their personal tax liability from shooting up. It

may not be as advantageous for someone whose income is not very high and who doesnot have any ancestral property.

Similarly, it will be particularly useful for taxpayers with a very high savings rate. Thereare many taxpayers in the high income bracket, whose Section 80C limit is quicklyexhausted by the Provident Fund and children's school fee. They will be able to get taxbenefits on other investments, such as insurance premium, equity-linked savingschemes and fixed deposits. However, somebody who is not able to save the 1 lakhunder Section 80C will not benefit from the additional deduction available to his HUF.


6/10

It is a fallacy that HUF is only meant for small businessmen and traders. BL Gupta (seepicture) is the director of finance in a listed company. He started his HUF in 1997 tolower his tax liability from the ancestral property. Bohra, a stock broker, uses theadditional deduction to bring down his tax.

Even so, keep in mind that once an HUF is established and assets are transferred to thefamily hotchpot, the income from these assets would continue to be assessed as HUFincome till the HUF is partitioned completely. This would amount to the individual givingup control over the assets.

For the same reason, it is essential that all coparceners of the HUF act in the bestinterest of the family. Even if one decides to part ways, it will have implications for theentire HUF. "Every co-parcener can demand the partition of the HUF property. Even ifone asks for his share, the entire HUF will have to be partitioned," points out PriyambadaSen, senior manager with Deloitte India .

Then again, not all tax benefits enjoyed by an individual are applicable to the HUF.

Experts warn that the clubbing provisions should especially be kept in mind when youtransfer personal assets to the HUF. It's possible that the income you think can beshifted to the HUF will actually be clubbed with your income and taxed in your hands.

http://economictimes.indiatimes.com/personal-finance/tax-savers/tax-news/How-to-use-

HUF-for-as-a-tax-planning-tool/articleshow/8643829.cms

More tax benefits you can avail from the HUFBy: Mahesh Agarwal

While the additional exemption and deduction bring your tax down, there are other waysin which you can benefit from the HUF.

Cuts wealth tax: If you are too rich, the taxman wants you to pay a small portion of thiswealth as tax. If you have a second house, which has not been let out, a luxury car, gold

jewellery, artefacts and hard cash, and the combined value exceeds 30 lakh, you needto pay 1% tax on the wealth exceeding the specified limit.

However, if some of this wealth of an individual is owned in the name of HUF, it reduceshis wealth tax liability.

No notional rent: Rental income is taxable in the hands of the owner, but even if youhave not rented out your second house and it is lying vacant, you will be taxed for thenotional rental income from the property. You will be spared the tax if the propertybelongs to the HUF. This benefit will only be applicable in 2011-12 because the newDirect Taxes Code, which is likely to come into effect from 1 April 2012, has removed thetax on notional rent.

Helps avoid service tax: If the turnover of a service provider exceeds 10 lakh in a year,he is supposed to charge service tax and deposit the amount with the exchequer. This
http://economictimes.indiatimes.com/personal-finance/tax-savers/tax-news/How-to-use-HUF-for-as-a-tax-planning-tool/articleshow/8643829.cmshttp://economictimes.indiatimes.com/personal-finance/tax-savers/tax-news/How-to-use-HUF-for-as-a-tax-planning-tool/articleshow/8643829.cmshttp://economictimes.indiatimes.com/personal-finance/tax-savers/tax-news/How-to-use-HUF-for-as-a-tax-planning-tool/articleshow/8643829.cmshttp://economictimes.indiatimes.com/personal-finance/tax-savers/tax-news/How-to-use-HUF-for-as-a-tax-planning-tool/articleshow/8643829.cmshttp://economictimes.indiatimes.com/personal-finance/tax-savers/tax-news/How-to-use-HUF-for-as-a-tax-planning-tool/articleshow/8643829.cms


7/10

pushes up the price of his services by 10.3% and makes him less competitive in themarket. However, if he splits the business turnover by setting up an HUF, the serviceprovider can avoid the hassle of charging service tax.

Small-scale industry exemption: For the business community, various exemptions andincentives given to small-scale units are crucial to ensuring healthy margins. However, ifthe annual turnover of the business crosses the 1.5 crore mark, the exemptions arewithdrawn. Again, splitting the business between the individual and the HUF will helpkeep the turnover within the prescribed limit of small scale industries and allow bothentities to avail of the exemptions.

No MAT or AMT: An HUF can also run a business. Unlike other corporate entities, thereis no minimum alternative tax on HUF owned businesses. This is a significant benefitand enhances a company's competitive advantage.

To ensure that small investors don't get elbowed out by deep-pocketed institutional

investors, all public issues have separate quotas for different categories of investors.The HUF is not only a separate taxpayer but also a distinct investor and is eligible toinvest in public issues just like any other individual.

Investing through the HUF has twin benefits: the 2 lakh limit for the investment to becategorized as retail is not breached and there is a greater probability of more sharesbeing allotted.

The author is a chartered accountant and senior partner of Mahesh K Agarwal & Co and

can be reached at

http://economictimes.indiatimes.com/quickiearticleshow/8646547.cms

5 ways HUFs can be made better

Minal Agarwal lists out five changes that are required in the HUF. These will remove

some of the disadvantages.

1.

In May 2005, the government passed a rule preventing HUFs from opening new

accounts in the Public Provident Fund. All existing accounts, which had completed 15

years since the initial deposit, were also to be closed by 31 March 2011. HUFs can't

invest in other government securities such as the National Savings Certificates, as well.

These restrictions should be done away with. Why should HUFs be treated differently

from any other taxpayer?
http://economictimes.indiatimes.com/quickiearticleshow/8646547.cmshttp://economictimes.indiatimes.com/quickiearticleshow/8646547.cmshttp://economictimes.indiatimes.com/quickiearticleshow/8646547.cms


8/10

2.

An HUF can pay for the life insurance premium of any member but cannot be the

nominee in such an insurance policy. This may appear logical because the death of the

policyholder will not impact the HUF as much as it will affect his dependants. However, if

the kartaof the HUF is crucial for its smooth functioning, the HUF should be allowed to

take a keyman life insurance cover for him and should be made the nominee.

3.

The 2005 amendment to the Hindu Succession Act, which accorded equal rights to

female co-parceners of an HUF, is only applicable to the Mitaksharaschool of Hindu

thought. It should also apply to the Dayabhaga school, which has a following in West

Bengal and Assam. Moreover, Kerala does not have an HUF system. For the sake of

uniformity, the same rules should apply across the country.

4.

HUFs are not eligible for some tax benefits that are enjoyed by individual taxpayers.

They should also be able to claim deduction for interest paid on education loans and

some benefits for pension fund contributions.

5.

While daughters have been giving equal rights as co-parceners, women are stilldiscriminated in HUFs. Right now, female coparceners can only manage the HUF in the

absence of a male member. The spirit of the 2005 amendment to the Hindu Succession

Act should be carried forward and women be allowed to be kartas of an HUF. In fact,

they should also be allowed to set up HUFs on their own.

Some of the changes mentioned above may sound too radical, but they are essential to

align the HUF concept with the requirements of modern times.

Minal Agarwal is a chartered accountant and partner Mahesh K Agarwal & Co

http://economictimes.indiatimes.com/personal-finance/savings-centre/analysis/5-ways-

hufs-can-be-made-better/articleshow/8644089.cms
http://economictimes.indiatimes.com/personal-finance/savings-centre/analysis/5-ways-hufs-can-be-made-better/articleshow/8644089.cmshttp://economictimes.indiatimes.com/personal-finance/savings-centre/analysis/5-ways-hufs-can-be-made-better/articleshow/8644089.cmshttp://economictimes.indiatimes.com/personal-finance/savings-centre/analysis/5-ways-hufs-can-be-made-better/articleshow/8644089.cmshttp://economictimes.indiatimes.com/personal-finance/savings-centre/analysis/5-ways-hufs-can-be-made-better/articleshow/8644089.cmshttp://economictimes.indiatimes.com/personal-finance/savings-centre/analysis/5-ways-hufs-can-be-made-better/articleshow/8644089.cms


9/10


10/10

how to use huf as a tax planning tool

Documents