In continuation to my previous article in the series “How HUF can help you save Taxes”, let us understand in this article, how forming an HUF can help you save taxes.

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If you look at the number of taxpayers constantly looking out for ways and means to save taxes and maximise their savings, you will find there are plenty. In fact, in their quest to save more taxes, taxpayers often end up investing in financial products which neither suit their risk profile nor aligned to their financial goals. And many a times, these investments are also done without a thorough research and analysis. So, does creating an HUF makes sense in terms of reduced tax liability and more savings? Well, the answer is yes provided it is done within the boundaries of our legal framework. Let us understand in detail:

How HUF can help you save taxes.

As I have briefly explained in the first part of this article series, your HUF commands an independent status with respect to tax framework. What it means is like it enjoys most of the benefits under taxation rules what applies to you as an individual tax payer, like it has its own PAN, the benefit of Income Tax Slabs like basic exemption limit and different slab rates based on your income level apart from the 80C deductions, all applies similarly the way it applies to you.

So, on forming your HUF, you can distribute your investments separately i.e. both in your own name and in your HUF’s name, which results in to you earning income in two different entities i.e. accounts. You will file two separate tax returns, one in your name i.e under your PAN and the second one would be under your HUF’s name. Similarly, you can invest up to Rs 1.50 lakh under section 80C investment options like paying for life or health insurance premiums (for HUF members)) via HUF account. This allows you to save close to Rs 2 lakhs in taxes on account of the benefits you are getting towards basic exemption limit of Rs 2.5 lakhs, 80C deduction for Rs 1.5 lakhs and the lower tax slab benefits. This happens because you and your HUF are two different legal entity for tax purpose and thereby results in to great tax savings. You can get similar benefit towards premium paid on health insurance policies under section 80D and also the amount spent on specified diseases or towards money spent on medical treatment of a dependent relative.

Now the question is how to transfer money to your HUF account, can you simply transfer money lying in your account to HUF account thereby resulting in to the above mentioned savings?

The answer is No, it is not that simple as it seems, let’s take our previous example of Manoj whose salary income is Rs 30 lakhs. Say, Manoj after paying off due taxes and meeting all his expenses and EMIs is left with Rs 5 lakhs savings which he wants to invest. Let’s assume that he wants to invest this money in a bank fixed deposit and as you are aware that Manoj has to pay tax on the interest income this FD will fetch him.

So, is it possible for Manoj to simply transfer these 5 lakhs to his HUF account and invest in a bank FD from there, will he get all the tax advantages as mentioned above and get away freely without paying taxes?

No, it doesn’t work like this because there will be tax implications on receiving gifts in certain cases. Though your HUF can receive gifts from its members to the tune of 4 lakh per annum without worrying about any tax implication because of the basic exemption limit benefit for Rs 2.5 lakhs and Rs. 1.5 lakh for section 80C or even more after considering the other deductions. After getting this money from its members, HUF can invest the same in any financial products, so say, Manoj transfers Rs 4 lakhs to his HUF and invest in a bank FD from HUF and earns interest on it, now since this money was gifted by Manoj to his HUF, hence any income what that investment will earn i.e. Rs 4 lakh in our example, has to be clubbed with the other income of Manoj. He has to show this income and pay due taxes so ultimately there is no benefit of tax savings due to this kind of transfer.

So the best way to avoid this tax issue is to create your HUF capital by the other assets which can be transferred like on account of a will or getting money or property in inheritance as that will not attract any tax liability. Like the property given to Manoj by his father can be directly transferred to his HUF and from there he can either get regular rental income or he can sale the property and invest the proceeds (net of capital gains) in a bank FD. Let’s assume that his HUF will earn Rs 6lakhs from rental or he earns Rs 6 lakh interest from his fixed deposit, now in any case there is no tax liability for the first 2.5 lakhs due to basic exemption limit and assume that HUF has invested Rs 1.5 lakh under 80C then total Rs. 4 lakh is exempted straightaway without any income tax liability. Even on the remaining Rs. 2 lakh , a lower tax slab of 10 and 20 percent will apply resulting in to further tax savings as compared to the case where Manoj would have taken this property in his own name than his HUF.

Rishabh Parakh is a chartered accountant and chief gardener at Money Plant Consultancy.

First Published:Sept 13, 2018 7:34 AM IST