One way to save on taxes is to set up a family unit and combine resources to create an HUF. This family structure has its own PAN and files taxes separately from its members.
A HUF is a distinct entity with its own PAN. If you channel some investments into the HUF, it can access many benefits that individuals receive, such as a basic exemption of ₹3 lakh under the new tax rules and up to ₹1.5 lakh in deductions under section 80C.
To establish an HUF, a married couple with at least one child must be involved, and eligible individuals include Hindus, Buddhists, Jains, and Sikhs.
An HUF comprises a karta, coparceners, and other members. The karta is in charge of transactions and can sign checks for the HUF. Coparceners are individuals who are born into the family, like a father and his son or daughter. Family members by marriage, such as a mother or wife, are considered regular members.
Example of HUF
Imagine a husband and wife earning ₹10 lakh and ₹15 lakh respectively, with part of their income coming from an inheritance. They’ve invested in stocks or mutual funds and made a profit of ₹7.5 lakh each this year (totaling ₹15 lakh). If they follow the new tax regime and realize profits on equities after keeping them for 12 months, their total tax for the year would amount to ₹3.36 lakh.
In contrast, if the couple moves some of their inherited money (with some transfer rules) into the HUF and invests it in mutual funds, ₹5 lakh of their ₹15 lakh capital gains would originate from the HUF. Instead of counting this income as part of their own, treating the HUF as a separate entity with its own PAN helps manage taxes better.
Here’s how it works: Without other income besides the capital gains, the HUF would show an annual income of ₹5 lakh. Out of that, only ₹2 lakh is taxable because income up to ₹3 lakh isn’t taxed under the new rules. Of the remaining ₹2 lakh, only ₹75,000 gets taxed at 12.5% (applicable long-term capital gains tax), considering there’s a threshold of ₹1.25 lakh before the tax applies. This strategy can enable the couple to save ₹55,000 on taxes.
However, moving wealth into an HUF isn’t as simple as it seems.
An HUF can be formed by inheriting property or assets through a Will or ancestral claims. While HUF members can give gifts to the HUF, these gifts won’t be taxed for the HUF, but the income generated from them will be taxed for the member who made the gift.
For example, a member may gift mutual fund units or property, but gains from selling those funds or rental income from the property will be taxed fully for the member. This is known as income clubbing.
Section 56(2)(x) of the Income Tax Act, 1961
Interestingly, if the gift comes from a non-member, it gets taxed for the HUF. If the total value exceeds ₹50,000, the HUF might face tax under Section 56(2)(x) of the Income Tax Act, 1961. Nevertheless, transferring assets to the HUF can lead to considerable tax savings by separating income.
If an HUF gets a ₹4 lakh gift, ₹2.5 lakh would be tax-free under the basic exemption limit of the old regime. The leftover ₹1.5 lakh may qualify for a deduction under Section 80C if invested in eligible options like Equity Linked Savings Scheme mutual funds, potentially creating a tax-free amount of up to ₹4 lakh each year. This amount could then be reinvested into financial options such as mutual funds to build a solid investment portfolio for the family.
An HUF can manage a business, invest in financial options like mutual funds or stocks, and earn rental income from its properties.
When it comes to opening an account, doing so for an HUF involves some steps. Once the account is set up, managing transactions is similar to a regular account.
Many mutual fund platforms allow users to create HUF accounts.
To open an account, the HUF needs to complete the KYC process through registration agencies. One can visit the MF Utilities site to download a form and then submit it with the necessary documents to a nearby Point of Service (POS).
MF Utilities has teamed up with two registrar and transfer agents, Cams and Kfintech, to set up POS locations. “You can send your documents by courier or deliver them in person,” said Monali Chitnis, who oversees operations at MF Utilities.
If the HUF has KYC registration already, it just needs to apply for a CAN registration, which is also a physical process. You’d need to download the application form and submit it, along with the required documents, at a nearby POS. Once approved, the HUF can invest online like any other account.
Dissolving the HUF
While setting up an HUF is straightforward, dissolving it can be much more complicated. “Dissolving an HUF requires an official order from the assessing officer that documents the complete partition of the HUF; without this, the dissolution won't be recognized, and the HUF's PAN will remain active. Moreover, partial partitions aren't acknowledged under Indian tax laws, which can lead to complications.
Also building an HUF capital takes time due to income clubbing rules. It’s best to view tax planning with an HUF through a long-term lens.
Additionally, if the karta plans to move abroad, they should be ready for possible tax and FEMA complications. The HUF structure may not be acknowledged internationally, which could lead to the loss of treaty benefits. Furthermore, many banks are reluctant to convert HUF resident savings accounts into HUF non-resident accounts, which can lead to operational hurdles.