Inheritance tax (IHT) – a tool for redistribution of wealth

Why Inheritance tax?

India abolished Estate Duty way back in 1985 and the argument is why again. The government is facing financial strains with the revenues slowing down and demand for public spending / providing financial assistance increasing. RBI survey conducted in 13 major cities during May 5-17 shows that consumer confidence has collapsed. Credit ratings agency, Moody’s Investor Services downgraded India’s sovereign rating to the lowest investment grade on June 1, 2020. The rating agency downgraded India’s ratings to ‘BAA3’ from ‘BAA2’ and also maintained the outlook from ‘stable’ to ‘negative’ The agency noted that the slow pace of reform and limited political effectiveness have contributed to a prolonged period of slow growth, which started before the pandemic and which Moody’s expects to continue well beyond.

In the meantime the Government has reduced Income tax rates and going forward it would be forced to reduce GST rates on select items to spur demand. All this measures will force the government to spruce up tax collections through imposition of fresh levies and it is quite likely that the Estate Duty in new form will be brought back. Keeping with the trend the new tax would be called Inheritance Tax and should follow the practices in USA or Europe. It is under this back drop that an attempt is made to have a possible structure that would be fair and an attempt would be tax only the top strata of the society and give relief to a vast majority. This will also help showcase that India is open to bold tax reforms to maintain fiscal discipline.

Undoubtedly, IHT is one of the most hated taxation on the ground that the estate of the deceased as been built up from income which has already been taxed in the life time of the deceased and to hat extent IHT would amount to double taxation. Another argument which has been forwarded is that as and when the asset inherited is sold it’s already subject to tax and consequently IHT is an unnecessary evil.

A pro-IHT argument is, IHT is a fundamental part to ensuring the continuance of the middle class. A strong middle class is essential to the health of a democracy. Without an inheritance tax, the upper class, super-rich themselves. The inheritance tax serves to democratize a society. Without it, we will have society where a few wealthy families control all of the wealth. In fact it is often argued that the generation which inherits huge wealth is not inclined to work hard for a living and lives off the pains / risk undertaken by their parents. This is unfair. The wealth in such cases has come as a windfall. Hence government should also get a slice of it which can be used for social welfare to scale up the living standards of the people in the bottom rung of society.

Low Personal tax collection

According to data released by Income tax department for FY 16-17 around 4.67 crore returns were filed by individuals during the year and personal income tax collected stood at ₹273,405 crore. The average tax paid by an individual was ₹58,576. Thus barely 4% of India’s population files tax returns. With a liberal tax rebate offered from FY 2019-20 the number of individual tax payers would fall further. There is already pressure to reduce corporate taxes and the need to shore up revenues from additional sources cannot be gainsaid. IHT fills this gap.

India is a developing nation with a large population being deprived of adequate opportunities. Governments would require money to ensure quality education, food, affordable housing and medical facilities at affordable costs. All these would require money – and this can come from IHT.

With low individual tax rates as compared to developed countries imposition of IHT is all the more equitable. Highest tax rate in USA is 37% and in UK it’s 45% compared to 30% excluding surcharge & Education cess. Following Finance Act 2020 the maximum marginal tax rate that an individual taxpayer has to pay in India is 42.744 per cent. This includes a basic tax rate of 30 per cent plus Surcharge of 37 per cent plus education cess of 4 per cent. However this rate is applicable only to individuals earning more than Rs. 5.00 crores (applicable to around 8000 individuals according to one data released by tax department). But for a vast majority earning less than Rs.1.00 crores the effective tax rate is 35.88%

International Practices:

In UK each individual can pass on up to £325,000 to their heirs tax-free. Above that amount, a tax charge of 40% is applied.

In USA for the estate tax exemption is $11.58 million per individual and the rates go up to 40% In Germany, inheritance and gift tax rates for individuals range from 7% to 50% with various exemptions available. Tax rates depend upon the nature of relationship. Looking to the Indian culture an ideal structure should be on following lines to make it equitable and should be on following lines:

Beneficiary Type  Beneficiaries other than “Others” shall be termed as relatives.	One Spouse / Live-in partner	Children Limited to two (Three if twins)	Parents	Grandparents & Grand children (limited to four grandchildren). Brother/ sisters to include only those having any of parent in common.	Others – Residual category Excluding transfer to registered charitable trust
Category of asset inherited
One residential / commercial property (mainly used for letting out)	Exempt	Exempt up to Rs. 100 lacs	Exempt up to Rs. 100 lacs to any one parent.	Exempt up to Rs50 lacs	Taxable
Financial assets	Exempt up to Rs. 150 lacs	Exempt up to Rs. 150 lacs	Exempt up to Rs. 75 lacs each	Exempt up to Rs. 50 lacs	Exempt up to Rs. 25 lacs
Jewellery	Exempt up to Rs. 25 lacs	Exempt up to Rs.10 lacs	Exempt up to Rs.5 lacs each	Exempt up to Rs.5 lacs	Taxable
Other assets (Residual category)	Taxable	Taxable	Taxable	Taxable	Taxable
Basic Exemption (Basic exemption limits can be double where the beneficiary of the estate is an individual who is physically challenged with more than 75% disability).	Rs. 200 lacs	Rs. 100 lacs	Rs. 100 lacs	s Rs. 100 lacs	Rs. 100 lacs. However, where the Others category applies because of deeming provisions viz. In case of children, grandparents/ grandchildren brothers or sisters the basic exemption can be Rs. 250 lacs
Tax rate	Flat rate 7% over the excess	In Slabs. Rates Ranging from 7% to 25%	In Slabs. Rates Ranging from 7% to 25%	Flat rate 15% over the excess	In Slabs. Rates from 35% to 50%

Beneficiary would be liable to pay IHT

Other provisions could be:

1. Credit of IHT paid earlier (period not exceeding 3 years) could be granted against future IHT liability arising from the death of the recipient of estate on inheritance. The benefit of credit can be taken by recipients being relatives as agreed mutually. This could nullify cascading effect.
2. The IHT can be paid within 18 months from the end of the FY in which the death of individual without levy of interest Additional time of 6 months could be given but in such cases interest could be charged – however to encourage early payment a discount could be given to those who pay within six months from the end of the FY. IHT attributable to immovable property could be paid within extended period of 3 years or on sale whichever is earlier. This would give time to the tax payer without the need to get into distress sale of assets acquired.
3. Credit of IHT would be granted against CG tax liability if the assets acquired on inheritance are transferred within 2 years from date of inheritance.
4. To avoid tax avoidance, any transfer to a non charitable trust, unlisted company/ LLP / firm in which such individual (of person whose estate is distributed on death) is not a beneficiary, should be considered as void if such transfer is made five years prior to death of individual. In such cases the beneficiary /beneficiaries (whether the share is predetermined or other-wise) shall be liable to IHT. However, this shall not apply if the recipient has paid Income tax on such transfer.
5. The assets received by the HUF under will, should be deemed to be inherited by Coparcener & members of HUF and IHT at flat rate of 10% can be levied on HUF on the market value of assets in excess of Rs. 250 lacs.
6. While valuing the shares in a listed company held in the capacity of promoter (& so declared in corporate filings) the shares would be valued @ 35% of MV.

The above structure would ensure that IHT would not cause hardship to a vast majority and it would be equitable and help redistribute wealth.