Can forming a HUF help you save tax? Experts explain who can create one, key benefits and what to consider

Many taxpayers wonder whether forming a Hindu undivided family (HUF) can help them manage their taxes more efficiently. Since an HUF is recognised as a separate taxable entity under the income tax law, it has its own tax treatment.

The entity comes into existence by operation of Hindu law when a family exists and Buddhist, Sikh, and Jain families can also form an HUF. In practice, it is usually constituted after marriage, when there is a common family unit.

An HUF has its own PAN and files a separate income tax return, allowing eligible income to be taxed independently, deductions and exemptions to be claimed separately, and family investments to be managed under a common entity.

Can a salaried person form a HUF?

A salaried employee can also form an HUF but merely creating one does not reduce tax. For an HUF to have any tax relevance, it must also have its own income and assets, according to experts who spoke to Mint.

A family member’s salary cannot be treated as HUF income and will always be taxed in the hands of the individual who earns it.

“There is a lot of misconception in today’s world where people believe that a HUF can be formed directly an income can be diverted for tax saving purposes,” said Suraj Singh, Founder of SD Singh & Associates, Chartered Accountants.

An HUF becomes tax efficient if it earns income from sources such as a family business, inherited property, rental income, investments or eligible gifts.

“Since HUF is a separate tax entity, it will have a separate basic exemption limit and can also claim the deductions applicable to HUF, thus helping families legally plan and distribute their income,” according to Siddharth Maurya, Founder & Managing Director of Vibhavangal Anukulakara Private Limited.

Key advantages of forming a HUF

The biggest advantage of an HUF is that it is taxed independently from its members. This means the HUF files its own ITR and enjoys the same slab rates and deductions available to an individual, wherever applicable under the chosen tax regime. Here are some benefits available to an HUF:

• Basic tax exemption: Like individual taxpayers, HUFs are also eligible for the basic tax exemption up to ₹2.5 lakh annually if they choose old tax regime and ₹4 lakh for those opting for the new regime.
• Section 80C deductions: HUFs are also eligible for deductions of up to ₹1.5 lakh under Section 80C of the Income-tax Act. This benefit is available on investments such as PPF, SSY, SCSS, among others.
• LTCG exemption for equity investments: If both the HUF and an individual family member have separate demat accounts, each can independently claim the annual long-term capital gains (LTCG) exemption of ₹1.25 lakh on equity investments. This allows the family to avail a combined exemption of up to ₹2.5 lakh in a financial year.
• Capital gains exemptions on property: HUFs can claim exemption from capital gains tax on the sale of a residential property by reinvesting the gains in another property. If the prescribed requirements are met, the tax liability on such capital gains can be reduced or eliminated.

Two very important point that people may miss are that the standard deduction and rebate benefit is not available to an HUF. Those benefits are available only to an individual taxpayer, Singh noted.

How taxation works for an HUF?

Let’s understand the tax treatment of an HUF with an example: Suppose an HUF earns ₹40 lakh as business income during a financial year. According to the current tax rates, the tax payable by the HUF on this income would be about ₹6.75 lakh (the exact amount may vary depending on the applicable tax regime, surcharge and health & education cess), Maurya said.

Now consider a different scenario. If instead of taxing the business profits in the HUF’s hands, the family income is taxed in an individual’s hands, the overall tax outgo could be higher. For example, if the husband already earns ₹40 lakh salary and the family business also generates a ₹40 lakh profit, both salaries will be taxed and a larger segment of salary will fall in the highest tax slab.

However, if the business income legally belongs to and is taxed in the HUF, the family gets the benefit of a separate taxpayer with its own tax slabs and eligible deductions. If all tax laws are complied with, can reduce the overall tax significantly, the expert added.

How to create an HUF?

According to Singh, the most important and the fundamental document for creating an HUF is the HUF deed, which consists of the following:

• Name of the HUF
• Name of the Karta
• Details of coparceners or members
• Date of creation.

Once the deed is ready, a PAN application can be made for the HUF which is the legal and identity for tax purposes. Once both the documents are ready, bank account can be opened and transactions can take place under HUF, he said.