Taxes can hurt, but one can be smart about them.
One of the many ways to save taxes is to create a family unit and pool assets to form a Hindu Undivided Family (HUF). An HUF has its own permanent account number (PAN) and files tax returns independently of its members.
“Think of an HUF like creating a separate individual with a PAN card. That way, if you can put some corpus/investments in the HUF, they will enjoy most benefits an individual gets, like the basic exemption of ₹3 lakh under the new tax regime, up to ₹1.5 lakh deduction under section 80C, etc.,” said Nitesh Buddhadev, a chartered accountant and founder of Nimit Consultancy.
To be sure, a married couple with at least one child can open an HUF account. Only Hindus, Buddhists, Jains, and Sikhs can opt for this.
An HUF has a karta, coparceners and other members. The karta is authorized to carry out transactions and sign cheques on behalf of the HUF. Coparceners are born into an undivided family, such as a father and a son or a daughter. Those coming from outside the family through marriage, like a mother and wife, are called members.
Tax savings
Let’s say a husband and a wife earn ₹10 lakh and ₹15 lakh, respectively, and part of their income came from inheritance. They have invested in mutual funds/stocks and booked a profit of ₹7.5 lakh each (total of ₹15 lakh) this year. Assuming they’ve opted for the new tax regime and booked the profits from equities after a 12-month holding period, the couple’s total tax liability would be ₹3.36 lakh for the year (see the graphic).
On the other hand, let’s say the couple transferred some corpus they inherited (conditions apply on transfers to HUF) from their parents to the HUF and invested that in mutual funds. That way, ₹5 lakh of the ₹15 lakh capital gains came from the HUF. In the first case, we assumed they had put it under their names. But having an HUF account is like creating a separate individual with a separate PAN card for tax purposes.
Here’s how it helps: Given that there is no other income apart from the capital gains in the HUF, the tax-saving instrument will record a total income of ₹5 lakh for the year. Out of that, only ₹2 lakh will be taxable. That’s because, in the new tax regime, income up to ₹3 lakh is tax-free. Of the remaining ₹2 lakh, only ₹75,000 will get taxed at 12.5% (long-term capital gains tax) as there is a threshold of ₹1.25 lakh before the capital gains tax kicks in. By doing this, the couple could save ₹55,000 in taxes.
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However, transferring copus/income to an HUF is not straightforward. Sagar Somen, a Nagpur-based chartered accountant, said HUF corpus can be created by inheriting property or assets through a Will or ancestral lineage in the name of the HUF. While an HUF member can give gifts to the HUF, it will be tax-free in the hands of the HUF, but the subsequent income from it will be taxable in the hands of the member who gave the gift.
For instance, a member can gift mutual fund units or house property, but the gains when the mutual funds are redeemed, or the rental yield of the housing property, will be fully taxable in the member’s hands. This is called clubbing of income.
Interestingly, if the gift comes from a non-member, it becomes taxable in the hands of the HUF. In such cases, if the aggregate value exceeds ₹50,000, the HUF might have to pay a tax on it under Section 56(2)(x) of the Income Tax Act, 1961. Still, if the corpus can be transferred to the HUF, significant taxes will be saved through the segregation of income.
“For instance, if the HUF receives ₹4 lakh as a gift, ₹2.5 lakh can remain tax-exempt under the basic exemption limit under the old regime. The remaining ₹1.5 lakh can qualify for deduction under Section 80C if invested in eligible instruments like Equity Linked Savings Scheme mutual funds, potentially creating a tax-free corpus of up to ₹4 lakh annually. This corpus can then be invested further in financial instruments like mutual funds to build a robust investment portfolio for the family,” said the Nagpur-based CA.
An HUF can own a business, invest in financial instruments like mutual funds, equities and fixed deposits, or generate rental income from real estate holdings.
Opening an account
Unlike individual accounts, creating an HUF account to invest in mutual funds is a physical process. Once the account gets created, the process of transacting works just like a normal account.
Most mutual fund transaction platforms allow users to create a HUF account.
To open an account, the HUF must complete the know-your-customer process through KYC registration agencies. One can go to the MF Utilities site to download a form for the same and submit it to a nearby Point of Service (POS) along with the required list of documents (see the chart).
MF Utilities has partnered with the two registrar and transfer agents, Cams and Kfintech, to set up POS in various places. “One can courier their documents or submit them directly,” said MonaliChitnis, who heads operations at MF Utilities.
If the HUF is already KYC registered, people only need to apply for a CAN registration, which is also a physical process. You have to download the form and submit it along with the required documents to a nearby POS. Once approved, the HUF can invest online like any other account.
What to expect
Pankaj Bhuta, a chartered accountant and founder of P.R. Bhuta & Co., Chartered Accountants, said as much as it is easy to create an HUF, dissolving it is much more complex. “Dissolution of HUF requires a speaking order to be passed by the assessing officer recording the total partition of HUF, without which it will not be recognized as a dissolution, and HUF’s PAN won’t be cancelled either. Additionally, partial partition is not recognized under the Indian income tax law, which can lead to tax-related issues.”
“Also, building the HUF corpus is a long-term process due to the application of clubbing provisions. Hence, tax planning through an HUF should ideally be done with a long-term perspective in mind,” he added.
He said if the karta intends to migrate outside India, he should be prepared for potential tax and FEMA issues. The concept of HUF may not be recognized outside India, thereby disentitling HUF from treaty benefits. Further, many banks are hesitant to convert HUF resident savings bank accounts into HUF non-resident ordinary accounts, causing operational challenges.
