Retail investors rush to set up HUFs to beat IPO allocation odds

What is an HUF?

Earlier, it was mostly business owners who wanted to set up an HUF to reduce their tax burden, since the income can be split between the person and the HUF, and brought under lower slabs.

An HUF is considered a separate legal entity and is treated as a "person" under the Income Tax Act. An HUF is a family that consists of people who are descended from a common ancestor. It includes wives and unmarried daughters, according to the definition given on the Income Tax department's website.

The sudden interest in setting up HUFs primarily has to do with how these entities are treated for IPO allocation. They can apply under the retail individual investor (RII) category, for which 35 percent of the book is reserved.

The other category under which an individual can apply is non-institutional investor (NII), for which only 15 percent of the book is reserved.

RIIs, which includes HUFs, are those who have less than Rs 2 lakh to invest. NIIs, which also includes HUFs, are those who have more than Rs 2 lakh to invest.

What investors do to improve their chances is that they split their capital in order to fall under the RII category. That is, if they have Rs 4 lakh to invest, instead of applying under the NII category, they set up an HUF and make two applications under the RII category. One using the HUF's permanent account number (PAN), and the other using their individual PAN details.

Even if they want to invest more capital under the NII category, they can add an extra application through an HUF.

Tax efficiency

So how are HUFs more tax efficient?

There are other ways through which an individual can increase their applications for an IPO, such as applying as a partnership firm set up between a husband and wife, or applying using their children's PAN, but they are not as tax-friendly as HUFs.

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Jajoo said, "Partnerships will be taxed at 30 percent of their taxable income, while the children's income will be added to the guardian's income, and the overall tax liability will go up. But HUFs are a separate entity, so their income will be taxed separately from the individual’s."

Thus, if a child's income is added to the guardian's income, then their combined income may enter a higher tax slab. But if the HUF’s income and the individual’s income are taxed separately, then each are likely to fall under a lower slab.

For example, if a person earns Rs 3 lakh, and the HUF earns Rs 2 lakh (total Rs 5 lakh), there would be no tax liability. On the other hand, if instead of the HUF it was the person’s child that had earned Rs 2 lakh, , then there would be a tax liability of at least 5 percent on the total amount, after standard deduction. This would apply even if the income is earned through an application made under the child’s name.

The only difference in the tax treatment between an individual’s income and an HUF’s income is that an individual can claim a tax rebate of Rs 12,500 on income of less than Rs 5 lakh, while an HUF can’t do so, said Jajoo.