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According to industry insiders, the number of people starting a Hindu Undivided Family (HUF) has increased due to the boom in the initial public offering (IPO) market. The idea is gaining traction as it increases the likelihood of being allocated shares in proposed IPOs, and in a tax-efficient manner.
Varun Jajoo, a chartered accountant, said the number of people approaching him to set up a HUF has increased three-fold in the last year since the IPO boom began. “A person can register as HUF from the first day of marriage. Previously, employees filed for IPOs only in their spouse's name. Now they have started setting up HUFs to add another application,” he said.
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An investment banking expert who has worked on several SME IPOs also told Moneycontrol that the number of people applying through HUFs has increased due to the IPO boom in SME companies.
What is a HUF?
In the past, it was mainly entrepreneurs who wanted to set up a HUF in order to reduce their tax burden, as the income can be divided between the person and the HUF and assigned to lower tax rates.
A HUF is considered a separate legal entity and is treated as a “person” for the purposes of the Income Tax Act. A HUF is a family consisting of people descended from a common ancestor. This also includes wives and unmarried daughters, as defined on the Income Tax Department website.
The sudden interest in setting up HUFs has primarily to do with how these companies are treated during IPO allotment. You can apply in the “Retail Individual Investor” (RII) category, for which 35 percent of the investment portfolio is reserved.
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The other category under which individuals can apply is Non-Institutional Investors (NII), for which only 15 percent of the investment portfolio is reserved.
RIIs, which include HUFs, are those who have to invest less than Rs 2 lakh. NIIs, which include HUFs, are those who have to invest more than Rs 2 lakh.
To improve their chances, investors divide their capital to fall into the RII category. That is, if they have Rs 4 lakh to invest, instead of making one application in the NII category, they set up one HUF and make two applications in the RII category. One uses the HUF Permanent Account Number (PAN) and the other uses its individual PAN details.
Also, if they want to invest more capital in the NII category, they can submit an additional application through a HUF.
Tax efficiency
How are HUFs more tax efficient?
There are other ways an individual can increase their applications for an IPO, such as: B. by applying as a partnership between a man and a woman or by applying with your children's PAN. However, these are not as tax friendly as HUFs.
Also Read: World's largest market for IPOs under $100 million is booming in India
Jajoo said: “Partnerships are taxed at 30 percent of their taxable income, while children’s income is added to the guardian’s income, increasing the total tax liability. But HUFs are a separate entity, so their income is taxed separately from that of the individual.
So if a child's income is added to the guardian's income, a child's total income may fall into a higher tax bracket. However, if HUF income and individual income are taxed separately, they are each likely to fall under a lower tax rate.
For example, if a person earns Rs 3 lakh and HUF earns Rs 2 lakh (total Rs 5 lakh), there is no tax liability. On the other hand, if instead of HUF, the person's child had earned Rs 200,000, there would be a tax liability of at least 5 percent on the total amount as per standard deduction. This also applies if the income is generated through an application made on behalf of the child.
The only difference in tax treatment between the income of an individual and the income of a HUF is that with an income of less than Rs 5 lakh, an individual can claim a tax refund of Rs 12,500 while the same is not possible with a HUF, said Jajoo.
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