Optimizing Family Wealth: A Tax Impact Analysis of HUF Structure

Optimizing Family Wealth: A Tax Impact Analysis of HUF Structure

In the intricate landscape of Indian taxation, the concept of a Hindu Undivided Family (HUF) holds a significant position, offering a unique avenue for family wealth management and tax planning. An HUF, recognized as a separate legal entity under the Income Tax Act, allows families following Hindu, Jain, Sikh, and Buddhist laws to collectively own property and earn income, thereby potentially optimizing their tax liabilities.

Concept of HUF

At its core, the formation of an HUF necessitates the presence of a minimum of two individuals related by blood or marriage, functioning within a familial framework. The members of an HUF are broadly categorized into two distinct groups:  A. Members and B. Coparceners. While all coparceners are members of the HUF, but not all members are coparceners.

Members of an HUF:

• A member of an HUF is any person who is part of the family by virtue of:
  • Lineal descent: All individuals lineally descended from a common ancestor, including their wives and unmarried daughters, are members. This extends to all generations.
  • Marriage: Wives of the male coparceners become members of the HUF upon marriage.
  • Adoption: An adopted child becomes a member of the HUF of their adoptive father.
• Membership in an HUF is broader and encompasses a wider range of family relatives.
• Members have certain rights within the HUF, primarily the right to maintenance from the HUF property. This includes basic necessities like food, shelter, clothing, education, and medical aid.
• Generally, members do not have the right to demand partition of the HUF property. Their claim on the property is usually through the coparceners.

Coparceners in an HUF:

• A coparcener is a member of the HUF who has a birthright in the joint family property. This right is acquired by birth into the family.
• Traditionally, only male lineal descendants up to four generations (including the head of the family) were considered coparceners under the Mitakshara school of Hindu law.
• However, the Hindu Succession (Amendment) Act, 2005, has significantly changed this. Now, daughters are also coparceners by birth, having the same rights and liabilities as sons in the ancestral property.
• Coparceners have significant rights, including:
  • Right to demand partition: Any coparcener, whether male or female, has the right to ask for a division of the HUF property.
  • Joint ownership: They have a joint interest and possession of the coparcenary property. No individual coparcener can claim exclusive ownership of any specific portion until partition.
  • Right to manage: While the Karta (head of the family) usually manages the HUF affairs, coparceners have a right to question the Karta’s actions if they are against the family’s interest.
  • Right to alienation (limited): Generally, a coparcener cannot sell, mortgage, or gift their undivided interest in the HUF property without the consent of other coparceners, except in specific circumstances like legal necessity or benefit of the estate (and with the Karta’s authority).
  • Right to maintenance: Similar to other members, coparceners also have the right to maintenance.

Let’s take an example –

Consider Mr. X, who, along with his parents and siblings, constitutes his father’s HUF. Upon marriage, Mr. X can establish a separate HUF with his spouse and children. Subsequently, his children, after their own marriages, can form yet another distinct HUF with Mr. X and his wife.

In his father’s HUF, Mr. X is both a member and a coparcener, granting him the right to demand partition. However, his wife, being related through marriage, is only a member of his father’s HUF and does not possess the right to demand partition, although she holds a right to maintenance.

This illustrates that an individual can be a member of multiple HUFs, while the senior most member typically assumes the role of the Karta.

HUF Formation Procedure:-

Creating an HUF (Hindu Undivided Family) involves formalizing its existence through a legal document called the HUF Deed. This deed outlines the structure, members, and initial assets of the HUF. Here’s a general guide on how to prepare an HUF Draft:

1. Gather Necessary Information:

• Name of the HUF: Typically, it’s the Karta’s name followed by “HUF” (e.g., “Mr. Ramesh Kumar HUF”).
• Details of the Karta: Full name, father’s name, address, age, and occupation of the Karta (the head of the family, usually the eldest male member). After the 2005 amendment, a senior female member can also be the Karta under certain circumstances.  
• Details of the Coparceners: Full names, father’s names, addresses, ages, and their relationship to the Karta. Remember that after the 2005 amendment, daughters are also coparceners by birth.  
• Details of other Members (if any): Full names, their relationship to the Karta, and addresses. This includes wives of male coparceners and unmarried daughters (who are also coparceners).
• Source of the Initial Corpus (Capital): How the initial assets of the HUF are being created. This could be from ancestral property, gifts received by the HUF, or loans. If it’s a gift, details of the donor and the amount should be mentioned.
• Address of the HUF: The official address for communication purposes.
• Date of Formation: The date on which the HUF is being formally recognized.

2. Draft the HUF Deed:

The HUF Deed should be a written document on stamp paper. It should clearly state the following:

• Title: “HUF Deed” or “Declaration of HUF”
• Declaration: A statement declaring the formation of the HUF with the specified Karta and coparceners/members.
• Details of Karta: Clearly identify the Karta and their role as the manager of the HUF affairs.
• Details of Coparceners: List all the coparceners with their relevant details and their relationship to the Karta.
• Details of Members: Include other members of the HUF who are not coparceners.
• Source of Corpus: Clearly mention how the initial assets were brought into the HUF. If it’s a gift, include a declaration of the gift and its acceptance by the Karta.
• Address of the HUF: State the official address.
• Operational Terms (Optional but Recommended): It may be included clauses regarding the operation of the HUF, such as the Karta’s powers, how decisions will be made (though generally the Karta has wide powers), and the procedure for future additions or removals of members
• Signatures: The deed should be signed by the Karta and all adult coparceners in the presence of two witnesses, who should also sign and provide their addresses.

3. Stamp the Deed:

The HUF Deed needs to be printed on non-judicial stamp paper of the appropriate value as per the stamp duty laws of the state where the HUF is being formed.

4. Notarization (Optional but Recommended):

While not legally mandatory for the validity of the HUF, getting the deed notarized by a notary public adds an extra layer of legal authenticity to the document. The notary will verify the identities of the signatories.

Procedure to Get HUF PAN

Once the HUF Deed is prepared, the next crucial step for tax purposes is to obtain a Permanent Account Number (PAN) for the HUF.

Documents Required for HUF PAN Application:

• Proof of Identity (POI) of Karta:
  • Aadhaar Card
  • Passport
  • Driving License
  • Voter ID Card
  • Ration Card with photograph
  • Any other photo identity proof issued by the Central Government or State Government.
• Proof of Address (POA) of Karta:
  • Aadhaar Card
  • Passport
  • Driving License
  • Voter ID Card
  • Ration Card with photograph
  • Electricity Bill (not older than three months)
  • Landline Bill (not older than three months)
  • Bank account statement (not older than three months)
  • Credit card statement (not older than three months)
  • Property Registration Document
  • Any other address proof issued by the Central Government or State Government.
• Proof of Date of Birth (DOB) of Karta: (Generally, the documents provided for POI also serve as DOB proof if they contain the date of birth).
• Proof of Existence of HUF:
  • HUF Deed: A copy of the duly executed and (preferably) notarized HUF Deed. This is the most important document to establish the existence of the HUF and the relationship between the Karta and other coparceners.
• Affidavit by the Karta: In some cases, an affidavit might be required, declaring the names, father’s names, and addresses of all the coparceners of the HUF. Check the latest guidelines of the Income Tax Department or the PAN service providers.

After getting PAN card HUF could apply for opening a bank account.  Even HUF could apply for TAN & GST No if HUF is running business.

Introduction of Capital in HUF

The introduction of capital is a crucial step in formally establishing and operating a Hindu Undivided Family (HUF) for tax and financial management purposes. The capital forms the initial corpus or the pool of assets that the HUF will own and manage collectively. Here’s an overview of the procedures and considerations for introducing capital into an HUF:

Sources of Capital for an HUF:

The capital of an HUF can come from various sources:

• Ancestral Property: This is the most common source of HUF capital. Property inherited through generations automatically becomes HUF property.
• Gifts: Members of the HUF, particularly the Karta or coparceners, can gift movable or immovable property to the HUF. Gifts from relatives (as defined under income tax laws) are generally tax-free in the hands of the HUF, up to a certain limit for non-members. Gifts from non-relatives exceeding ₹50,000 in a year are taxable.
• Loans: The HUF, through its Karta, can take loans from Financial Institutions or from it’s Members which become part of its capital, although these need to be repaid from HUF’s Account.

If HUF applies for loan from Financial Institutions then HUF has to mortgage HUF’s Property. In that case Karta / Co-parceners will have to be co-applicant and if HUF fails to pay EMI then Co-applicant will be liable to repay.

• Business Income/Rental Income: Income generated from a family business owned by the HUF adds to its capital. Example-A family running medical business and in that case that family could form HUF to run medical business more strategically. Even HUF could ear rental income by letting out property.

The Income Tax Act, particularly Section 64, contains provisions regarding the clubbing of income, which can have significant implications when assets are gifted to a Hindu Undivided Family (HUF) by its members or non-members.

1. Gifting of Assets to HUF by a Member and Clubbing Provisions (Section 64(2))

If a member of an HUF transfers their individual property (movable or immovable) to the HUF, the income derived from such property by the HUF will be clubbed with the income of the individual who transferred the asset that means Gift from members is not taxable in the hands of HUF.

2. Gifting of Assets to HUF by a Non-Member and Clubbing Provisions

Gifts received by an HUF from non-members are generally taxable in the hands of the HUF if the aggregate value of such gifts received during the financial year exceeds ₹50,000.

Generally, the income arising from assets gifted to the HUF by a non-member is not clubbed with the income of the non-member donor. Once the gift is validly made to the HUF, the income generated from that asset belongs to the HUF and is taxable in its hands, subject to the applicable tax rates for HUFs.

Purchasing & Investing by HUF

HUF can buy land , shares , mutual funds with it’s own fund having in bank account just like an Individual buys property and invests in capital market. Even HUF can apply for IPO also like individual.

HUF Tax Slab:

The income tax slabs applicable to an HUF are the same as those for individuals, and the HUF is eligible for deductions under sections like 80C and 80D. Notably, an HUF investing in a member’s Public Provident Fund (PPF) can also claim a deduction under Section 80C. However, the rebate under Section 87A is not available to HUFs.

Practical Example – Mr. Sharma’s salary income Rs. 12 lacs p.a. In addition to that he has two demat accounts and he has earned 1.5 lakh LTCG from each demat account and also earned Rs. 12 lakh from parental property.

Note –

HUF has a Separate Entity and Separate PAN . But HUF can not be partner / director in any partnership firm or Pvt.ltd company as HUF is not a real person. However HUF can be a shareholder in a company and because of being a shareholder it can make nominee also. Whatever a HUF is doing transactions in a financial year , HUF must file it’s ITR otherwise notices u/s 148A would be there from IT Department.

When an assessee has multiple sources of income / income from ancestral property then an HUF can be a strategic tool for tax optimization, it generally cannot have salary income, however the standard deduction for house property income is applicable. Non-Resident Indians (NRIs) can also form HUFs, with tax implications depending on the HUF’s location. NRIs can form HUF and implication of tax depends upon HUF location.

Dissolution of HUF:

An HUF is not dissolved but rather undergoes partition or separation, where assets are distributed among members or sold, with the proceeds and investments being divided. Income Tax law recognizes HUF partition as a non-taxable event.

Suppose a person has three children and father is running HUF with their children. Later on three children want to be separated to live with harmony; in that case Income Tax recognizes HUF Partition and HUF Partition is not taxable event as per Income Tax Law.

Conclusion:

The HUF structure presents a viable avenue for optimizing family wealth and potentially reducing the overall tax burden. Understanding its formation, operational nuances, and the intricate interplay of income tax provisions is crucial for effectively leveraging this financial tool. However, it is imperative to seek professional legal and financial counsel to ensure proper structuring, compliance with tax regulations, and alignment with the specific financial goals of the family. Careful planning and adherence to legal frameworks are essential to maximize the benefits of an HUF while navigating the complexities of Indian taxation.