Pitfalls of inheritance tax: Double taxation

With the Finance Minister starting a debate on it, there needs to be clarity on how wealth tax will be treated

As they say, the only two things certain in life are death and taxes. And soon there could be another addition to the income tax list — inheritance tax — one that is imposed on the beneficiaries of a deceased assessee’s estate.

This levy has many names like ‘death duty’, ‘estate tax’ (levied on the total value of the estate) or ‘inheritance tax’ (levied on the ultimate beneficiaries of the estate). Over the years, it has been a subject of a lot of contention globally. This led to some countries (Australia, Singapore and Canada) abolishing this levy and some others (Norway and Switzerland) diluting it considerably. This tax is levied with the aim of reducing the scope of potentially perpetual inequality arising due to the transfer of assets from one generation to another.

In India, inheritance tax was levied between 1953 and 1985. Here are the details of it -

• It was payable by the executor of the estate of a deceased under the Estate Duty Act, 1953, till June 16, 1985.  
• As per this legislation, the tax was levied on an ‘accountable person’, that is, a person having a right of disposition over property of the deceased, in respect of the property passing on to that person through various different types of settlements and dispositions.  
• Property, if passed two years before the death was not taxed, but any disposition within two years of death potentially was liable to estate duty. The estate duty was payable on a slab basis.  
• All assets below a threshold limit of Rs 1 lakh were exempted while determining the taxable value of the estate. In case of co-parceners inheriting a Hindu Undivided Family’s (HUF) property, this threshold was lowered to Rs 50,000.  
• The tax was payable only by legal heirs other than the spouse. If a person inherited property on the death of a spouse, no tax had to be paid.  
• There was also a provision for relief to avoid double taxation in case of assets inherited in other countries.  
• The minimum slab rate was 7.50 per cent and the maximum rate was 40 per cent of the principal value of the estate in excess of Rs 20 lakh.

Inheritance tax was eventually abolished in 1985, due to the following reasons -

• It was deemed by many, to be too complex, owing to a slew of different valuation rules for different kinds of property.  
• This in turn, led to several tax demands being subject to lengthy litigation.  
• The collections from estate duty (around Rs 20 crore) were not commensurate with the high overt and covert cost of collections.

The topic has gained prominence once again as the Finance Minister P Chidambaram recently said he is mulling a reintroduction of this levy. He had plans to reintroduce inheritance tax in 2011 also but it did not happen. Chidambaram’s statement has set alarm bells ringing in some quarters. People argue that when the deceased has already paid income tax and (in many cases) wealth tax each year for possessing the assets, it is harsh to levy inheritance tax on the same assets as this in a way amounts to double taxation. Some also fear that this tax may affect foreign capital flows into India, although, this seems a little far fetched, to say the least.

The Finance Minister’s ostensible reason for the re-introduction of inheritance tax is the same as before — reduction in inequality. However, it may also be driven by revenue considerations. Besides, considering that today, it is much easier for the Income Tax Department to track assets, the cost of collection may be much lower. Also, if a simple and transparent set of valuation rules are devised, the threat of frivolous litigation may be considerably reduced.

In case such a tax comes into effect, here are some ways in which you could reduce its impact -

Setting up a Trust
In many countries, where such a tax is levied, assesses set up a ‘trust’ in which they ring-fence the assets instead of directly bequeathing them to their heirs. In India, too, one could avail of this option, by creating an ‘irrevocable trust’.

In an irrevocable trust the creator of the trust (known as the grantor / settlor) fully surrenders ownership of the assets and has them re-titled in either the name of the trust or the trustee(s). This loss of ownership is one of the disadvantages of an irrevocable trust, at least for a grantor seeking to retain control during their lifetime. Of course, such a trust must be created in consultation with domain experts, so as to avoid derive the maximum benefit.

Gifting
One may also gift the asset to the intended beneficiary during one’s lifetime. In India, any gift up to Rs 50,000 a year is not chargeable to tax. Moreover, gifts, received from certain specified relatives (including spouse, spouse’s brother / sister, own brother / sister or brother / sister of either of the parent or any lineal ascendant or descendant of that individual or any lineal ascendant or descendant of the spouse of that individual or spouse of any of the persons aforementioned) are fully exempt without any ceiling. However, the drawback here too is the loss of control of the asset during one’s lifetime. Let us hope that if an inheritance tax is re-introduced, the threshold limit is very high (say Rs 10 crore and above), there is be a long list of exempted assets and the rate of tax will not be punitive (not exceeding 10 per cent).

The writer is head – Marketing, PPFAS Asset Management