Inheritance tax: An idea doomed to failure

If levied, within 20 years we will see a repeat of V P Singh's 1985 Budget speech proposing abolition because of its meagre yield and high cost of collection

The discussion on inheritance tax in the media reminded me of the story titled The Great Sermon Handicap by my favourite author P G Wodehouse. In the story, the owner of a priceless family heirloom — a silver cow creamer — steals it himself intending to sell it to a rich American collector. It’s a complicated plot with many misunderstandings typical of Wodehouse’s work. Bertie Wooster and his butler Jeeves get involved. Ultimately, Jeeves rescues Bertie with his superior intellect and problem-solving skills. The story is set against the backdrop of the ruinous estate duties prevailing in Britain then. There were many loopholes in the estate duty. Family heirlooms were one asset on which estate duty was not payable, but they could not be sold. Hence, the holder of the family heirloom steals it to sell it.

Like most Wodehouse stories, it is a laugh riot from cover to cover. It also reveals the complexities high estate duty introduces and the lengths to which taxpayers will go to avoid it.

In our socialist past, taxpayers had to pay an annual wealth tax on assets owned by them as well as a stiff estate duty on the taxpayer’s death. This was on top of income tax rates as high as 90 per cent. Not surprisingly, tax evasion was rife.

Over the years, estate duty, gift tax (for relatives), and wealth tax were removed and income tax rates were made reasonable. Tax compliance improved and tax collections jumped.

Inheritance tax is always coupled with a tax on gifts to relatives. If there is no gift tax, taxpayers will gift the assets rather than will them. But the inheritance tax’s biggest issue is that the two main forms of wealth — real estate and controlling stakes in companies — are illiquid. The taxpayer finds it difficult to keep those assets and yet find the money to pay the tax.

The case for an inheritance tax in India is weak. A narrow sliver of the population holds the bulk of the wealth, given the inequality levels. The share of financial assets in the wealth is low. A few families hold the majority of controlling stakes in companies. A maze of complex structures holds these. These structures serve many purposes. They include reducing the impact of an inheritance tax imposed in the future.

Most of the non-financial wealth is in agricultural land, which is not even defined as an asset in the Income-Tax Act. It is doubtful if any political party will take the risk of alienating this powerful class. Hence, those most affected by this tax will be the upper levels of the salaried class and professionals — the biggest beneficiaries of liberalisation. They also hold most of the financial assets, which are trackable and will need to bear the brunt of any future inheritance tax.

Truth be told, it is human nature to enjoy the difficulties faced by people better off than themselves. Inheritance tax is popular among the masses since it affects a narrow segment of the population. However, collections from inheritance tax are meagre everywhere in the world. According to Wikipedia, only 2,500-odd estates paid the tax in the USA in 2021. Despite this, if inheritance tax is ever levied in India, I will stick my neck out and make two predictions. First, within 20 years of the tax being levied, we will see a repeat of V P Singh’s Budget speech of March 16, 1985, in which he proposed the abolition of estate duty because the yield from it was meagre and the cost of collection high. The second prediction is on a lighter note: The legal, tax and financial planning profession as well as life insurance companies will have a field day.

Note: I have used the terms “estate duty” and “inheritance tax” interchangeably though there are differences between them.

The writer heads Fee-Only Investment Advisors LLP, a Sebi-registered investment advisor; X (formerly Twitter): @harshroongta