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How to set up a HUF to save taxes in the right way?

Posted on 23 Jun 2024
Author: Sayan Sircar

Tags: Tax

9 mins read
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This article explains what you need to do to save tax by creating a HUF.

How to set up a HUF to save taxes in the right way?

This article is a part of our detailed article series on the concept of tax saving using HUF in India. Ensure you have read the other parts here:

How to Save Taxes on Stock Dividends in India Using HUF?

This article explains how HUF taxation works, the rules on transfers and gifts, and the best strategies to build a dividend-paying portfolio under HUF ownership.

Frequently asked questions on saving tax via Hindu Undivided Family (HUF): the complete guide

This article compiles an exhaustive list of FAQs on the concept of tax saving by creating an HUF.

📚 Table of Contents

How does a HUF save tax?
A worked-out example for tax saving with HUF
Effective Strategies for Asset Transfer into a HUF
Transfer to HUF that does not save taxes
Transfer to HUF that actually saves taxes

How does a HUF save tax?

Summary

HUF is recognized as a separate taxable entity, complete with its own PAN and bank accounts.
This setup allows for the tax-effective distribution of income from assets like real estate, stocks, or mutual funds.
However, not all transfers into an HUF are beneficial. Direct gifts or below-market transactions do not get the benefit.

A Hindu Undivided Family (HUF) is a separate “taxable person” in terms of tax payment with its own PAN card and bank account. Any income (rent, interest or capital gains) from assets correctly transferred to the HUF will be taxed separately. The HUF should consider which tax regime is best for it: old or new.

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A worked-out example for tax saving with HUF

Here is a HUF with ₹10 lakhs of rental income and ₹30 lakhs of salary income operating in the new tax regime using the calculator here: Which is the best tax regime to choose from April?

(amounts in ₹ lakhs)	Without HUF	With HUF
Rental income	10.00	10.00
Salary income	30.00	30.00
Total income of members	40.00	30.00
Total income of HUF	0.00	10.00
Tax on rent	combined with salary	0.62
Tax on salary	9.36	6.24
Total tax	9.36	6.86
Saved tax	–	2.50

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Effective Strategies for Asset Transfer into a HUF

Myth: You can transfer unlimited money to HUF and save taxes.

Fact: Transfers from members get clubbed back. Only ancestral property, certain gifts, or partitioned assets avoid clubbing.

Transferring assets into the HUF, to save tax, is not easy. There are two rules that need to be followed:

if you gift or transfer any asset without adequate consideration then the income from that asset is clubbed with the person making the transfer
only ancestral property and small gifts from non-members, less than ₹50,000/year, can be transferred into the HUF

In this article, assets refer to

cash in the bank or otherwise
immovable property like real estate
movable property like shares and mutual funds

It is important to note that assets once transferred into the HUF give ownership rights to all HUF members.

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Transfer to HUF that does not save taxes

Direct gifting of personal assets without consideration

If you, as a HUF member, gift a property worth say ₹50 lakhs (market value) to a HUF for free (no consideration) or at below market price, then income from this property (rent or capital gains) will be taxed in your hand due to income clubbing rules.

Low-Interest Loans to HUF

If you, as a HUF member, loan ₹10 lakhs to the HUF at say 1%/year and the HUF invests the amount at 5%, then on paper there is no tax on the 4% difference in returns. This plan is considered a form of tax evasion that is illegal.

Members transferrring money into the HUF

We will understand this case under Section 56(2)(x).

Unfortunately, while members of the HUF can transfer any amounts into the HUF without incurring gift tax, the income on that transfer will be clubbed into the hands of the members who made the transfer.

There is no limit to the transfer itself to make it gift-tax free, such as ₹50,000/year.. However, suppose the HUF generates income on this, via interest or dividends. In that case, that income is clubbed into the hands of the member who made the transfer, thereby negating any tax savings.

To understand if you should create your own HUF:

Transfer to HUF that actually saves taxes

Ancestral property transfer

Any ancestral property passed down, via father/grandfather/great-grandfather, to the HUF will be exempt from both gift tax and tax on future rent or capital gains. There will not be any clubbing.

Property transfer via will

As in the above case, a property transferred to the HUF via a will, whether from a member or a non-member, is also similarly tax-free.

Gift from non-members

Non-members, who are not a part of the HUF, are automatically not relatives of the HUF. We know that from non-relatives, only gifts up to ₹50,000/year are tax-free. Therefore, if a HUF receives up to ₹50,000/year as gifts from non-members, it is tax-free.

Growth of assets already in the HUF

If the HUF invests its own assets and gets income/rent/capital gains, then that is tax-free and not clubbed.

Partitioning an existing HUF

Any assets transferred into a different HUF by splitting (partitioning another HUF) are similarly tax-free.

Frequently Asked Questions (FAQs)

What is a Hindu Undivided Family (HUF) in terms of tax?

A Hindu Undivided Family (HUF) is considered a separate 'taxable person' under Indian tax law, complete with its own PAN card and bank account. Income from assets transferred to the HUF, such as rent, interest, or capital gains, is taxed separately from individual income.

How can creating a HUF save on taxes?

By creating an HUF and transferring assets to it, the income from these assets is taxed separately from the individual's income. This can lead to lower combined tax liability under certain conditions, especially if the HUF falls into a lower tax bracket.

What are some effective strategies for transferring assets into an HUF?

Assets like cash, immovable property, and movable property such as shares and mutual funds can be transferred into an HUF. It is important that the transfer adheres to tax laws to avoid income clubbing, and only ancestral property or small gifts under ₹50,000 per year are typically advisable for transfer.

What types of asset transfers to an HUF do not save taxes?

Transferring personal assets to an HUF without adequate consideration, such as a high-value property gifted without any payment, will not save taxes. The income generated from these assets will be clubbed with the individual's income, negating any potential tax benefits.

How do low-interest loans to an HUF work?

If an HUF member lends money to the HUF at a low-interest rate, and the HUF invests this at a higher rate, theoretically, the difference in earned interest could be tax-free. However, this setup can be considered tax evasion and is illegal.

What is the tax treatment of ancestral property transferred into an HUF?

Ancestral property transferred into an HUF is not subject to gift tax and the income from it, such as rent or capital gains, does not undergo clubbing with the donor's income, making it tax-efficient.

Can HUF receive gifts from non-members?

Yes, HUFs can receive gifts from non-members. However, only gifts up to ₹50,000 per year are tax-free. Gifts exceeding this amount will be taxed.

What happens during the partitioning of an existing HUF?

When an existing HUF is partitioned, the assets transferred into a different HUF as part of the partition are typically tax-free, ensuring no additional tax liability from the process.

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