Tax Planning with HUF: Step-by-Step Procedure to Create an HUF

Interested in optimizing your tax planning and maximizing your tax savings? A Hindu Undivided Family (HUF) could be an excellent strategy to consider. As a separate tax entity, a HUF can provide several benefits for managing your family’s finances while minimizing taxes. The following guide will walk you through the simple and hassle-free process of creating a HUF specifically for tax planning. Here are the steps you need to take to harness the power of HUF and maximize its tax benefits. Let’s take a look at the step-by-step process for creating a HUF and taking advantage of its tax benefits.

Tax Planning Benefits of Forming an HUF

A Hindu Undivided Family (HUF) is treated as a separate tax entity by the Income Tax Department in India, offering several tax planning benefits.

1. Additional basic exemption limit: An HUF enjoys a separate basic exemption limit for income tax purposes. This means that the HUF can have additional income exempt from tax, in addition to the individual exemptions available to its members. By utilizing this additional limit effectively, the HUF can reduce its overall tax liability.

2. Income splitting: One of the key tax planning benefits of a HUF is the ability to distribute income among family members. This allows for income splitting, wherein the HUF can allocate income to members who are in lower tax brackets. By doing so, the overall tax burden is minimized, as the income is taxed at lower rates.

3. Deductions and exemptions: Similar to individuals, a HUF can claim deductions and exemptions available under the Income Tax Act. This includes deductions for expenses incurred for the benefit of the HUF, such as donations to charitable organizations, medical expenses, insurance premiums, etc. By strategically utilizing these deductions and exemptions, the HUF can further reduce its taxable income.

4. Tax-efficient investment opportunities: By forming a HUF, you can explore tax-efficient investment avenues. The HUF can invest in tax-saving instruments like Public Provident Fund (PPF), National Savings Certificate (NSC), Equity-linked Savings Scheme (ELSS), etc., and enjoy the associated tax benefits. This allows for effective tax planning while growing the HUF’s wealth.

Example 1

Consider a family with three members: Mr. A, Mrs. A, and their son, Mr. B. Each family member has an income exceeding Rs 15 lacs from various sources.

The family also owns an ancestral property that generates an annual rental income of Rs 15 lacs. If this rental income is taxed in the hands of any family member, it would fall into the 30% tax bracket, given their individual income levels.

Now, let’s examine the scenario if the family forms an HUF and the rental income is reported in the HUF’s hands. The HUF, as a separate entity, has a basic exemption limit of Rs 2.5 lacs. Therefore, the initial Rs 2.5 lacs of the rental income would not be taxed, leading to a direct tax saving of Rs 75,000 (30% of Rs 2.5 lacs).

The next Rs 2.5 lacs (income from Rs 2.5 lacs to Rs 5 lacs) would be taxed at 5% in the HUF’s hands. If it were taxed in the hands of an individual family member, it would be taxed at 30%. Therefore, on this Rs 2.5 lacs, the tax saving would be Rs 62,500 (difference of 25% tax on Rs 2.5 lacs).

Adding these up, forming a HUF for this family would result in a total tax saving of Rs 1,37,500 (Rs 75,000 + Rs 62,500).

Example 2

This example illustrates how a HUF can be a beneficial tool for tax planning, especially for families with substantial income from sources such as rental properties.

Consider a Hindu Undivided Family (HUF) that owns two properties: one self-occupied and another that is let out. The self-occupied property has a housing loan on which the HUF pays an annual interest of Rs. 2,50,000. The let-out property has an annual rental income of Rs. 6,00,000 and an annual interest payment of Rs. 3,50,000 on its housing loan.

Here’s how the HUF can claim deductions and compute taxable income from these properties:

Self-occupied property:

Under section 24(b) of the Income Tax Act, 1961, the gross annual value of a self-occupied property is considered as NIL. Furthermore, the HUF is entitled to claim a deduction of up to Rs. 2,00,000 on the interest paid on the housing loan for this property.

Therefore, in this case, although the HUF pays Rs. 2,50,000 as interest, it can claim a deduction of only Rs. 2,00,000. The income from this property for tax purposes is thus NIL.

Let out property:

The rental income from this property is Rs. 6,00,000 and HUF paid interest on the loan of Rs. 3,50,000 on this property.

However, the HUF can claim the entire Rs. 3,50,000 paid as interest on the housing loan as a deduction without any limit. Therefore, the net income from this property that is subject to tax is Rs. 2,50,000 (Rs. 6,00,000 – Rs. 3,50,000).

In conclusion, through the effective use of the provisions of the Income Tax Act, 1961, the HUF can reduce its tax liability by appropriately claiming deductions on the interest paid on housing loans for both self-occupied and let-out properties.

HUF Tax Rates and Liability to Pay Tax

Liability to Pay Tax: Hindu Undivided Families (HUFs) are taxed when their income exceeds Rs. 2,50,000. A HUF that earns more than this threshold in a financial year is required to file income tax returns and pay due taxes.

Tax Rates:  HUFs are taxed at the same rates as individual taxpayers. A HUF is taxed according to the same brackets as individuals, and it has no distinct tax slabs and rates.

Option for New Tax Regime: Assessees of HUFs have the option to choose the old or new tax regime. The new tax regime, introduced in the 2020 Budget, offers lower tax rates but restricts some exemptions and deductions. In choosing a HUF’s tax regime, it is essential to evaluate its income components and financial objectives carefully.

Rebate u/s 87A: The tax rebate offered under Section 87A of the Indian Income Tax Act, 1961, is not available for Hindu Undivided Families (HUFs). The tax rebate under Section 87A of the Income Tax Act, 1961, in India, is available to individual taxpayers. If the individual’s total taxable income is below a certain threshold, they can claim a rebate which could potentially reduce their tax liability to zero.

As you’ve noted, the finance act has introduced to increase the income limit for claiming this rebate from Rs 5 lakh to Rs 7 lakh under the new tax regime. This means if an individual’s total income does not exceed Rs 7 lakh, they could be eligible for a tax rebate under Section 87A if the assessee opts for a new tax regime.

Preventive Health Checkup: In the context of a HUF, any payments made for preventive health check-ups are not eligible for deductions. This means that while individuals may claim deductions for such expenses under certain sections of the Income Tax Act, HUFs cannot avail of these benefits.

Deduction under Section 80CCD: Section 80CCD of the Income Tax Act, 1961 provides provisions for deductions on contributions made towards the National Pension System (NPS). However, a HUF does not qualify for these deductions. This means that, unlike individual taxpayers, a HUF cannot claim deductions on contributions made to the NPS under this section.

How to Create HUF?

Remember, the HUF is automatically in existence from the time of marriage. The steps below are formalities for recognition of HUF for legal and tax purposes.

1. Family and Assets: The very first requirement for forming a HUF is a family. The assets of a HUF are typically received as a gift, or inheritance, or come from a will or from the sale of joint family property.

2. Deed Creation: Create a HUF deed. The deed should include details like the name of the Karta (head of the family), co-parceners (other members of the HUF), and the details of the assets of the HUF.

3. Declaration: All adult members of the HUF need to make a declaration stating the formation of the HUF and confirm that they have pooled assets to create the HUF.

4. PAN and Bank Account: Apply for a Permanent Account Number (PAN) in the name of the HUF and use this PAN to open a bank account for the HUF.

5. Capital Contribution: All initial contributions to the HUF should be made through the HUF bank account.

6. HUF Stamping: The deed should be printed on stamp paper and notarized.

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