The debate on inheritance tax has intensified after Indian Overseas Congress chairman Sam Pitroda described the inheritance tax in the US as an “interesting law” in the context of redistribution of wealth. Priyansh Verma explains the nitty-gritties of inheritance tax

What is inheritance tax?

It’s a tax that an individual must pay for inheriting a property or asset from his or her ancestor. In several countries, when the assets of a deceased individual is inherited by a legal heir, he or she has to pay an inheritance tax.

At present, India does not levy any tax on legal heirs, nominees, or beneficiaries when they inherit a movable or immovable asset. But, tax laws do apply to any income gained from inherited assets or property. For instance, if an individual inherits a house, he/she will not need to pay inheritance tax on it, but will need to pay applicable taxes if they rent out the house or sell it.

A wealth tax is a tax charged on the assets of individuals above a certain wealth threshold. The purpose of this tax is to reduce inequalities in wealth. A gift tax is a type of transfer tax levied on money or property that an individual or firm gives another.

Contours of such a potential levy

Experts say an inheritance tax, if introduced, could be levied on the transfer of assets, which would involve valuing the deceased’s entire estate, including movable and immovable properties, investments, etc., as on the date of death. “Progressive tax rates could then be applied, with exemptions or thresholds to minimise the burden on low to middle-income families while targeting wealthier estates,” Sandeep Jhunjhunwala, Partner, Nangia Andersen.

Anti-avoidance measures like a “look-back” period and taxing certain gifts/transfers before death could prevent tax evasion. A dedicated tax wing would assess, collect, and ensure compliance through audits and enforcement. Clear legislative frameworks, robust administrative systems, taxpayer education would be crucial.

Lessons from India’s earlier tryst with it

Inheritance tax was introduced in 1953, under the Estate Duty Act, but was abolished by the Rajiv Gandhi-led government in 1985. The high cost of collections, tax avoidance, and double taxation were cited as reasons for scrapping it. India also had a gift tax and a wealth tax, which were abolished in 1998 and 2015, respectively. In the Budget for FY16, the government had announced the abolition of wealth tax and its replacement with a surcharge on the super rich. At present, a 10% surcharge is levied on personal income over Rs 50 lakh. The maximum surcharge rate is 25% as per the new tax regime, if annual income exceeds Rs 2 crore. In 2019, the government had discussed internally the possibility of reintroducing the inheritance tax. It was part of the Budget formulation exercise, but the idea didn’t materialise.

Addressing income inequalities

Some say such a tax may address inequalities, as the levy on larger inheritances captures a more significant portion of wealth. This revenue can then fund public services, and initiatives benefiting underprivileged sections. “This also limits the inter-generational transfer of wealth, promoting economic mobility and reducing wealth concentration,” says Jhunjhunwala.

But others disagree. “India is still not a developed country. Until we generate enough wealth, we shouldn’t think of introducing such a levy,” said Sudhir Kapadia, partner – tax & regulatory services, EY India.

Other countries’ experiences

AT LEAST 26 countries, including Italy, Belgium, Japan, South Korea, France, Spain, Netherlands, Germany, United Kingdom and the US, have been imposing inheritance tax in the range of 4-80%. However, in the US certain types of trusts can help avoid estate taxes. An irrevocable trust transfers asset ownership from the original owner to the trust beneficiaries, without any payment of inheritance tax.

Boosting the state exchequer

Bringing in an inheritance tax can lead to an increase in tax collections by tapping into a previously untapped source of revenue, inherited wealth. This tax can generate substantial income for the government, particularly if structured effectively and applied to larger estates. But, on the other hand, it may discourage savings and investment, as individuals may be reluctant to accumulate wealth if a significant portion is to be taxed upon inheritance. “This could lead to disputes and litigation, causing additional financial and emotional burden on legal heirs,” Akhil Chandna, Partner, Grant Thornton Bharat.