While there are several benefits and drawbacks of HUFs in tax compilation, you might be able to save on your income tax by forming a Hindu Undivided Family since such households generally have a joint income instead of individual incomes.
Introduction to the concept of Hindu Undivided Family in Tax Procedures in India:
Hindu Undivided Family, or more commonly known by the abbreviation HUF, is a term used to denote of a common ancestor and every one of his lineal male offspring together with their spouses and spinster daughters. Hence an HUF comprises of everyone in the family; males in the family by default, females until they are married and those women married into the family. In this perspective, ‘Hindu’ mean those born into a Hindu family. Section 2 of the Hindu Succession Act, 1956, spell out that it applies to any individual, who is a Hindu by birth and it comprises a Virashaiva, a Lingayat or a devotee of Arya Samaj, Brahmo or Prarthana, a Sikh, a Jain or a Buddhist. HUF is a distinct unit for tax policy as per the provisions of section 2 (31) of the Indian Income Tax Act. It implies that this one person (usually the eldest male) can be deemed as the Karta or Head of the household.
Benefits of HUF System:
- The first and the most obvious benefit of HUF is when you add up tax. Tax Planning via HUF boosts the number of quantifiable units using the method of HUF partition.
- You can form different taxable units of HUF using the loopholes of will or gift. Any asset or savings made or insurance premium disbursed by the HUF is subtracted from the net income for tax purpose.
- You can agree or settle on a comfortable arrangement regarding partition while saving on tax. For instance, if an HUF comprises of a Karta (father) and four adult sons and they have two business units, a house and other miscellaneous income sources. If the HUF members are not earning, then partition can be done by giving each enterprise to two sons so that partition is impartial. This will significantly bring down tax liability.
- A woman is part of her husband’s HUF as well as her father’s. Even though a woman cannot start a separate account as the husband is the Karta, she can be the co-partner in the HUF. The additional income earned by the woman cannot be added to this.
- One can observe that the official stature of an HUF remains the same even in the hands of women in the event of the demise of Karta or the last male member in the family. Hence the ancestral or acquired assets of the HUF stays in the hands of the widows and need not be partitioned.
- The reason why a lot families decide to form an HUF is because they can apply for two pan cards and file taxes separately and personal incomes of members needn’t be considered as the HUF income.
- Thanks to many recent rulings, it is now accepted that there is no requirement for nucleus or ancestral joint family assets for the HUF to exist.
- Women in the family, if they want, can gift property in her name (or assets bought in her name by herself or her natal family) can make a gift of towards the HUF.
- HUF members find it easy to avail loans.
Drawbacks of HUF Setup:
- A Hindu Undivided Family (HUF) is formed by design when one marries. But to be documented by income tax officials, it should show some kind of money-spinning asset and this can only be in the form of a gift from a close kin or via a Will for every HUF member.
- Generally, the Karta of an HUF cannot gift or alienate HUF property but he can make certain gifts to the female members. Gift of immovable property within reasonable limits, can also be made by a Karta to his wife, daughter, daughter-in-law or even to a son out of natural love and affection. Gift of immovable property within reasonable limits can be made only for dutiful purpose e.g. marriage of a daughter etc.
- After a property gets apportioned to an HUF, every coparcener has equal right to it. So it is not transferrable and should be sold only if all the members agree to it. Partition of HUF land has often led to clashes and court cases.
- An HUF is not allowed to become an equal partner in any company. The Karta (head of family) or even an HUF member is allowed to represent the HUF in an enterprise. Women can also do that. But the income earned can be taxed as it falls under the category of the ‘HUF income’.
- Financing an HUF can be complicated. Resources can be brought in only via inheritance or gift (conditional on gift tax laws - amount exceeding INR 50,000 from non-family members is taxable).
- If you form an HUF with the sole aim of saving on tax, it may work only in the beginning. As the HUF strength escalates with passing years, technical hitches do too. Also, if the income tax department gets wind of this, they might take action against the HUF.
- As HUF is purely an Indian phenomenon, it is not recognized in other countries. With some members moving abroad for studies or job, the income assessment become a challenge.
- An HUF can be broken only if all the concerned party agrees to it.
- Women cannot combine her separate assets with the property of the joint family.
- HUF works only if you are earning a lot (high income level) from numerous sources.