A Common Question which a Taxpayer usually asks a Chartered Accountant at the time of filing his Income Tax Return is – Sir, How can I save my Taxes? He enters the office of a Chartered Accountant with full confidence that he would be able to avoid paying some portion of his taxes. And they to some extent their expectations are right. As CA’s have studied Taxes in detail, it is our moral duty to educate our fellow Indians about the various options available to them w.r.t. saving Taxes legally?
I know that there are several illegal ways to avoid Taxes but that is not at all recommended and when we have Legal Ways of Saving Tax, why should we be using Illegal means.
This article highlights how to save tax legally by forming an HUF
What is a HUF?
HUF stands for Hindu Undivided Family. In India, there is a culture of Joint Families and there are many Incomes which arise to the Family as a whole and not to one specific Individual say for e.g. Rent. If Rent is received from a property which is jointly owned by all the Members of the Family, that Income will be taxed in the hands of the whole Family and not in the hands of one specific Individual.
Logic behind Forming an HUF to save Taxes
Basically the logic behind forming an HUF is to avail the benefit of an extra PAN Card legally. As the Income of the Family is not taxed in the hands of any specific Individual, a new PAN Card is allotted to the HUF and Tax would be paid by the Family using this PAN Card.
As a new PAN Card would be allotted to the whole family, it will also enjoy the benefits of Income Tax Slab Rates i.e. Income would be Tax Free up to the specified limits and would then be taxed progressively at 10%, 20% & 30%.
The following would become clearer with the help of an example:-
Let’s assume there are 4 Members in a Family – Husband, Wife and 2 Children.
Husband’s Income – Rs. 25 Lakh p.a.
Wife’s Income – Rs. 18 Lakh p.a.
Joint Rental Income – Rs. 8 Lakh p.a.
The common misconception amongst Taxpayers is that this Rental Income would either be taxed in the hands of the either
- Husband; or
- Wife or ;
- Sometimes they split this amongst the Husband and the Wife and show it accordingly
In all the 3 cases, you would be paying Income Tax @ 30% as both the Husband and the Wife fall in the category of the highest slab rate which would be Rs. 2,40,000 p.a.
However, there is a better way out by which you can plan your Income Tax. As this Income is arising in the hands of the whole family, this Income shall be taxed in the hands of the Family (provided an HUF is formed) and you would be able to enjoy the benefits of slab rates.
As per the Current Slab Rates, the Income Tax that would be payable would be in the range of Rs. 60000 – 70000 (depending on the other tax saving techniques you implement.) And this would result in Tax Saving of Rs. 1,80,000 p.a. (Rs. 2,40,000 – Rs. 60,000)
For easy understanding of the concept, we explained this article using only Rental Income, but there are many other Incomes as well which arise to the family as a whole wherein the concept of saving taxes by forming an HUF can also be applied.
How to create HUF?
A false impression among people is that an HUF “needs to be created” where as an HUF comes into existence automatically at the time of marriage of an Individual. No Formal Action is required to be taken at the time of marriage for creation of an HUF and only a creation deed is to be furnished on a Stamp Paper (optional).
As HUF stands for Hindu Undivided Family, individuals belonging to other religions are not allowed to form HUF’s except Jain and Sikh who can create HUF even though they are not governed by the Hindu Law.
An HUF consists of
Karta: Karta is generally the father of the family who has the right to do all the things for the family and takes all the decisions on the behalf of the family.
Co-Parceners: Coparcener is the person who has the right to demand the share of the property of family if he/she wants to part away with the family with his/her share.
Not all members of the HUF are its coparceners. The co-parcenery extends to four degrees down the family hierarchy in the following manner:
- 1st degree: Holder of ancestral property for the first time.
- 2nd degree: Sons and daughters
- 3rd degree: Grandsons.
- 4th degree: Great grandsons.
How to put funds in HUF?
There can be numerous ways, some popular ways are –
- One can receive gifts from members of bigger HUF’s, who though your relatives, aren’t members of your smaller HUF.
- Parents can also gift funds to an HUF via gift deed clearly specifying that gift is directed towards Son’s HUF and not towards the Son.
- Gifts can be accepted from strangers but only up to INR 50,000 (section 56, income tax act, 1961)
Benefits of forming an HUF
- HUF is eligible for deductions under section 80D (insurance premium paid on health of its members), 80G (donation), 80L (income from bank and post office deposits), 80C (assorted list of items) under Income Tax Act. 1961
- A HUF also enjoys exemptions under sections 54 and 54F in respect of capital gains.
- HUF also gets advantage of slab rate taxability.
- Also, under Wealth Tax Act, 1957 HUF is treated as a distinct entity and enjoys separate taxability.
Specific Tax Planning Tools for an HUF
- Create more assessable units by partition of HUF – The tax liability can be reduced by partition of the HUF. This can be easily done in a case where the partition results in separate independent taxable units.
- Remuneration to the Karta & members – pay remuneration to the Karta and its members for the services rendered by them to the family business. The remuneration so paid would be allowed as a deduction from the income of the HUF and thereby tax liability of the HUF would be reduced
- Making loans to members of HUF can be used an effective tool in tax planning. Loan can be made with or without interest.
- Providing gifts to members of HUF does not attract gift tax liability.
- Family Settlement / Arrangement – Family settlements / arrangements are also effective devices for the distribution of ancestral property. Since family arrangement does not involve transfer, it would not attract gift tax, capital gains tax or clubbing.
As the cost of forming HUF is only a few thousand rupees and that too is a onetime cost, it is highly advisable for everyone to form an HUF and implement this technique.