With the increase in HNIs in India and lower administrative costs, one may justify an inheritance tax, but a transparent set of rules and a realistic threshold limit are necessary to avoid hardships for taxpayers
As India strives to enhance its growth trajectory in todays difficult economic environment, it is faced with rising fiscal debt. For financial year 2012-13, the fiscal debt till September 2012 is already touching 66% of the budget estimate, up from 37.4% at the end of June 2012. Fiscal consolidation (raising government revenues and cutting expenditure) is the need of the hour. But growth in both personal tax and corporate tax collections for the financial year till July 2012 has decelerated. The 2G spectrum auction has not lived up to expectations. However, the government is committed to its expenditure and is finding ways to increase revenue. Recently, finance minister P Chidambaram encouraged the authorities to debate over the inheritance tax while addressing a National Institute for Public Finance and Policy function.
Inheritance tax is a levy paid by a person who inherits money or property, or a tax on the estate (total value of the money and property) of a person who has died. When one dies, the government assesses the worth of the estate of the deceased, which may include cash in the bank, investments and any other property or business owned by the deceased. If the value of the estate exceeds the inheritance threshold set by the government, the deceased (technically, his estate) will pay tax on the same at the rate fixed by the government of the country.
It is a powerful fiscal measure used to counter increasing government debt in many countries such as the US, the UK and Germany, where inheritance taxes provide millions in revenue. In the US, like every time, it has been a controversial aspect of the Presidential elections. An estimate shows that the proposed repeal of the inheritance tax in the US after 2010 would have reduced revenues by $290 billion through 2015. President Obama has stuck with the inheritance tax during his tenure. Mario Monti, Italys technocratic Prime Minister, has reintroduced higher inheritance tax rates upon his induction in crisis-stricken Italy.
So, it is no small wonder that one can hear slight whispers of its reintroduction in India. India is not new to this tax. Inheritance tax, or estate duty, was levied between 1953 and 1985. All assets below a threshold limit of R1 lakh were exempt while determining the taxable value of the estate. For Hindu Undivided Family (HUF) property, this threshold was R50,000. The minimum slab rate was 7.50% and maximum rate was 40% of a principal value of the estate in excess of R20 lakh. Property, if passed to heirs two years before the death, was not taxed. The tax was payable only by legal heirs and if a person inherited property on the death of a spouse, no tax had to be paid. But, this was abolished in 1985 citing its inability in achieving its objectives of reducing unequal distribution of wealth and assisting the states in financing their development plans.
Authorities may be contemplating its reintroduction due to its impact on fiscal revenue. It may help the government support its fragile public sector companies and vulnerable social programmes. One may also view inheritance tax as a tool to redistribute wealth. Without such a tax, one perpetuates inherited wealth and hence heirs of the rich stay rich. In a country like India, which is plagued by social and economic inequalities, the levy of inheritance tax may be justified by some for its ability to combat this trend.
However, it is necessary to understand the consequences of the levy of an inheritance tax in the Indian scenario. With the increase in high net worth individuals in India and lower administrative costs, one may justify its reintroduction, but a transparent set of rules and a realistic threshold limit are necessary to avoid hardships for taxpayers. The objectives and implications of inheritance tax must be debated in depth for better understanding of the pros and cons of its possible levy, before any decisions are made.
The author is partner & national leader, Human Capital, Ernst & Young. Views are personal
India follows a regime of progressive taxationin which the rich are taxed at higher rates vis--vis the poor. The levy of one more tax need not necessarily correct the gap between rich and poor unless systemic reforms are undertaken
Equality of opportunity goes hand-in-hand with taxation of inheritance. Reduction in perpetual inequality was one of the reasons for the introduction of the inheritance tax in India in 1953. However, the yield from the inheritance tax was much lower than its cost of administration. The inheritance tax was abolished in 1985. Finance minister P Chidambaram recently called for a debate for the reintroduction of this tax in India.
It is believed that it is in the best interests of a welfare state to tax the rich so that they do not get an unjustified head-start at the expense of others. As of today, a wealth tax is levied at the rate of 1% on net wealth exceeding R30 lakh and covers assets such as residential and farm houses, urban land, jewellery, bullion, etc. Effective from 1993-94, wealth tax has been abolished on assets like shares and debentures. However, the collections from the wealth tax are meagre, in the region of R1,200 crore per year.
The estate tax in its earlier avatar covered almost all assets of the deceased. The highest slab rate in 1985 was 85% on an estate exceeding R20 lakh. Given that India is producing more and more millionaires, there is arguably a case for the levy of an inheritance tax to improve inter-generational equity, promote philanthropy and increase government revenues. However, Indias millionaires (in dollar terms, which is around R5 crore or higher) constitute only around 0.01% of the countrys population. It may be important to debate on how much tax can really be collected from such a small base to benefit society at large. Also, the levy of a wealth tax and inheritance tax will be a double whammy for the taxpayers.
In the Indian context, it is equally difficult to define the rich class. For example, an individual could only inherit a residential house in a prime metro location from the deceaseds estate, and on the basis of market value of such property he may get covered under the tax net. To be able to pay inheritance tax, the heir may have to sell the house. Also, take a case of a promoter owning a 50% stake in his business entity. While on a market cap basis, he would qualify to be a high net worth individual, his heir may have to dilute the holding to pay the taxes, leaving him without control in the business. The inheritance of assets like intangibles, interest in the partnership firm or palatial properties (which may not have real buyers) could lead to similar hardships. Personal assets like jewelery or art effects tend to have emotional values and it can be really de-motivating if one has to part with these assets to be able to pay tax.
India follows a regime of progressive taxationin which the rich are taxed at higher rates vis--vis the poor. The levy of one more tax need not necessarily correct the gap between rich and poor unless systemic reforms are undertaken, such that economic growth benefits all classes of society.
Clearly, people have worked around the inheritance tax in the past and have learnt how to manage their tax rather than pay itby gifting their assets, settling property in trusts, etc. While the resource-generation aspect is desirable, the levy was proving a source of harassment for both the assessee and the heirs. Reasonable tax rates and an efficient assessment mechanism would have to accompany the introduction of another tax in India.
So what do we expect from the finance minister now A phoenix to rise from its ashes, in the form of a comprehensible and mutually acceptable law or a zombie from its grave as a draconian law, which would bring with it scope for litigation and resistance from assesses, only to be eventually abolished once more
The author is Partner, Tax, KPMG India. Falguni Shah of KPMG India contributed to the article