What Constitutes a Hindu Undivided Family (HUF)

In the Indian tax context, there is an interesting concept called Hindu Undivided Family or HUF. As per the country’s tax laws, HUF has a unique business identity and therefore attracts different tax treatment and tax benefits. If you are a Hindu and part of a HUF, you can save tax by following a few rules as per the HUF Act. 

Here’s everything you need to know about Hindu Undivided Family, what is it made up of, and how it attracts different tax treatments.

Meaning of HUF

Hindu Undivided Family (HUF) comprises individuals who are direct descendants of a common ancestor, including wives and daughters of the male descendants. So, for example, a man, his wife, along with their two children can form a HUF and claim applicable tax relaxations.

What does the Income tax act say

As per the Income Tax Act and for the purpose of tax assessment, the Hindu Undivided Family is to be treated as a ‘person’ under the provisions of section 2(31). A HUF can have its own Permanent Account Number (PAN) and therefore file tax returns independent of its members.

Features of HUF

1. A HUF includes a ‘karta’ who is generally the eldest member or head of the family.
2. The other members of the family are ‘coparceners’.
3. The ‘karta’ looks after the day-to-day management of the HUF.
4. Children are considered coparceners for their father’s HUF.
5. If a daughter in the family gets married, she is considered a member of her husband’s HUF. However, she can continue to be a coparcener in her father’s HUF.
6. Although Jain and Sikh families do not come under Hindu law, they are also allowed to form HUFs for tax benefit purposes.

What is needed for HUF formation

As per Hindu Law, HUF is a family made up of people who are lineally descended from a common ancestor, including wives and unmarried daughters. Some of the criteria for HUF formation are:

1. A Hindu Undivided Family must include a minimum of two members to be considered a joint family.
2. HUFs are not created by a contract since these are automatically created in a Hindu Family.
3. A HUF must be formed by a family and one person cannot form it.
4. A HUF automatically gets created at marriage.
5. Hindus, Jains, Sikhs, and Buddhists can form HUFs.
6. HUFs generally possess assets in the form of gifts, a will, ancestral property, joint family property or property bought using a common pool of funds by HUF members. However, it is not important for a family to have an estate or property to form a Hindu Undivided Family.
7. It is important for a HUF to be formally registered once it is formed.
8. Every HUF should have a legal deed containing details of HUF members and its business.
9. HUF should also have a PAN number and a bank account opened under its name.

How is HUF taxed and other important points

1. Separate tax claims

A HUF is considered a separate individual and is therefore taxed separately from its individual members. Any tax deductions or exemptions are therefore allowed to be claimed by it separately. 

For instance, if a family of four including wife, husband and 2 children set up a HUF, all 4 members and the HUF can claim deductions under Section 80C. Thus, setting up a HUF can help families to build assets. 

2. PAN card and IT returns

HUF must have its own PAN and should file IT returns separately. 

3. Insurance

HUF can buy insurance policy coverage to protect its members.

4. Salary

If the members of a HUF contribute to its management and functioning, the HUF can pay a salary to them for the services rendered. Such salary expenses can be deducted from the income of HUF.

5. Investments

HUF’s income can be invested by the members. Returns from such investments will be taxable in the hands of the HUF and the tax rates applicable will be the same as an individual.

What are the benefits of forming HUF

HUFs are mainly formed by families since these are considered a separate legal entity, has separate PAN card and bank account. This helps in separating any joint tax obligations and other financial aspects of individual family members. 

It is easy to form a HUF. Once formed, the “karta”, can avail an additional basic tax exemption of Rs. 1.8 lakh in a financial year. HUFs also get the benefit of lower tax slabs since 10% tax is applicable for income up to Rs. 5 lakhs and 20% on income up to Rs. 8 lakhs.

Factors to note before forming a HUF

Although HUF may sound like an easy way for families to save tax, it has some drawbacks that should be noted before forming one. The table below highlights these factors to be considered:

Equal rights of members	HUF members have equal rights on any property owned by the HUF. Further, any additions to the family, through birth or marriage, are considered part of the HUF and have equal rights. As it grows, it can become difficult to manage with many members.
Difficult to close down	HUF can be dissolved only by way of partition. For this, all the members must be in agreement. At the time of closing down, all assets are equally distributed to members. This can cause disputes.
Nuclear families	Since people prefer to have nuclear families these days, HUFs are losing relevance.
Continued assessment until partition	If a HUF is formed, it has to continue filing tax returns, unless a partition takes place. This can be a hassle for those family members who may have formed a HUF but may not be using its legal existence.

Conclusion

Family members who are looking to set up a HUF for tax benefits must ensure to have a balanced HUF. Since HUFs come with both, benefits and drawbacks, members must think through the purpose for setting it up and take the decision wisely. If a HUF is set up and there is any dispute arising within the family, it can result in losses that each member will be liable towards.

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