Inheritance Tax: Meaning, Need, Significance and Challenges

Table of Contents

Introduction:

Inheritance tax, also known as estate tax, is a tax imposed on the assets of a deceased person before those assets are passed on to their heirs or beneficiaries and is to be paid by the person inheriting the fortune.
The tax is usually based on the total value of the deceased person’s estate, including cash, real estate, investments, and other assets, minus any debts and liabilities.
The purpose of inheritance tax varies by country, but it often serves as a source of revenue for the government and may also be used to promote social or economic objectives, such as wealth distribution or funding public services.

• In 2022, the top 1% of the Indian population owned 40.1% of total wealth and earned 22.6% of total income, while the bottom 50% owned 6.4% of total wealth and earned 15% of total income. The fate of the bottom 50% looks even worse when compared with the top 10% who owned 65% of total wealth and earned 57.7% of total national income.

History of inheritance tax in India and some other countries

In 1953, India introduced the Estate Duty ‘Death Tax’ Act, imposing tax on property transferred after an owner’s death. The tax applied to movable and immovable property, including agricultural land, above a set limit. It was applicable if the deceased was over 18 years old. The tax rate was based on market value at death.
After implementation, the death duty imposed peaked up to 85%, making it highly unpopular. In 1985, the then Finance Minister V.P. Singh under the Rajiv Gandhi government abolished it as the income generated for the Centre via such taxes was much less than the cost incurred due to the administrative process in executing it.
As of date, there is no tax imposed on property inherited, whether through a will or by intestate succession. This is in stark contrast to several other countries as most European, American and even African nations levy inheritance tax. In Europe, the top nations levying tax on inherited properties are — France (60%), Germany (50%), United Kingdom (40%), Spain (33%) and Hungary (18%). Other countries with high inheritance taxes are Japan (55%), South Korea (50%), Ecuador (37%), Chile (25%), South Africa (25%) and Taiwan (20%).

Inequality-adjusted Human Development Index (IHDI)

• The Human Development Index (HDI) is a summary measure of key dimensions of human development: a long and healthy life, a good education, and a decent standard of living.

• The IHDI accounts for inequalities in HDI dimensions by “discounting” each dimension’s average value according to its level of inequality.

• The IHDI value equals the HDI value when there is no inequality across people but falls below the HDI value as inequality rises. In this sense, the IHDI measures the level of human development when inequality is accounted for.

What other similar taxes does India have?

a) Gift Tax

Similar to Estate duty, India also had the ‘Gift Tax’ Act, passed in 1958. The Act allowed imposition of duty on any ‘gift’ made by one person to another in that financial year.
A gift was defined as any existing movable or immovable property transferred by one person to another voluntarily, without considering its value in terms of money, after April 1, 1957.
All taxable gifts were imposed with a duty of 30%. However, due to similar constraints to those faced while implementing estate duty, this tax was scrapped by the government in 1998.
However, in 2004, gift tax was reintroduced in the Finance Act as part of additions to the Income Tax Act. Any cash gifts above ₹50,000 and any gifts in kind (i.e. immovable property) above the value of ₹50,000 are taxable. Exceptions include donations, inheritance, and gift money received during weddings.

b) Wealth Tax

Another similar tax in India was the wealth tax introduced in 1957 to impose a duty on a person’s net worth. Under this regime, a 1% duty was imposed on earnings of over ₹30 lakh earned by a citizen in that financial year. The tax was imposed on all assets of Indian citizens and only Indian assets of non-residential Indians (NRIs).
Assets under the purview of this regime were gold, silver, and platinum ornaments, transport vehicles like private aircrafts, ships, and cars, property apart from one’s residential home, and any cash above ₹50,000.
Exemptions underthe law included rental properties, business property, smaller properties below the prescribed limit, and investments in schemes. This tax was also abolished in 2015 due to heavy costs in execution.

Growing demands for the implementation of an Inheritance Tax in India

There are several reasons behind the growing demands for the implementation of an Inheritance Tax in India:

a) Wealth Inequality:

India, like many other countries, has been experiencing growing wealth inequality. An inheritance tax is seen as a way to redistribute wealth and reduce the concentration of wealth among a small segment of the population.

b) Revenue Generation:

With increasing fiscal challenges, the government seeks additional sources of revenue. An inheritance tax could provide a substantial stream of income, especially considering the large fortunes being passed down through generations.

c) Fairness and Equity:

Proponents argue that an inheritance tax promotes fairness by ensuring that individuals contribute to society based on their inherited wealth. It prevents the perpetuation of dynastic wealth and creates a more level playing field for all citizens.

d) Encouraging Meritocracy:

By taxing inherited wealth, there’s an incentive for individuals to earn their wealth through merit and hard work rather than simply relying on inherited fortunes. This can foster a culture of entrepreneurship and innovation.

e) Global Trends:

Many countries worldwide have inheritance taxes or similar wealth transfer taxes. Advocates point to these global trends as evidence of the viability and effectiveness of such taxes in addressing economic and social concerns.

Benefits of inheritance tax

Inheritance tax, when properly implemented, can offer several benefits:

a) Revenue Generation:

Inheritance tax provides a significant source of revenue for governments, which can be used to fund public services, infrastructure projects, and social welfare programs. This revenue can help reduce budget deficits and support economic development.

b) Wealth Redistribution:

By taxing large inheritances, inheritance tax helps redistribute wealth from affluent families to the broader society. This can help mitigate wealth inequality and promote a more equitable distribution of resources.

c) Promotion of Meritocracy:

Inheritance tax can reduce the advantage of being born into a wealthy family by requiring individuals to contribute a portion of their inheritance to society. This promotes meritocracy by ensuring that success is based more on individual effort and talent rather than inherited wealth.

d) Prevention of Dynastic Wealth:

Inheritance tax discourages the accumulation of dynastic wealth by imposing taxes on large estates passed down through generations. This encourages wealth to be invested productively rather than simply being passed on to heirs.

e) Closing Tax Loopholes:

Inheritance tax helps close tax loopholes that allow individuals to transfer wealth to their heirs tax-free. By taxing inheritances, governments can ensure that all citizens contribute their fair share to the tax system.

f) Encouragement of Charitable Giving:

Inheritance tax often includes exemptions or deductions for charitable bequests, encouraging individuals to leave a portion of their estate to charitable causes. This can incentivize philanthropy and support nonprofit organizations.

• In 2018, the former Union Finance Minister Arun Jaitley claimed that inheritance tax was the reason for large endowments to hospitals, universities, and other institutions in the West. Contrasting it to India, he stated funding for such institutions were mainly from religious groups and corporate social responsibility (CSR) programmes. He claimed that endowments from rich individuals were not a norm in India.

Overall, inheritance tax can contribute to a more equitable society, reduce wealth concentration, and ensure that the tax burden is distributed fairly among citizens.

Challenges in implementing inheritance tax in India:

a) Complexity:

Designing a fair and effective inheritance tax system requires addressing complex issues such as valuation of assets, exemptions, and enforcement mechanisms. Ensuring that the tax is not overly burdensome to administer while still capturing a significant portion of wealth transfers is a considerable challenge.

b) Tax Avoidance and Evasion:

Wealthy individuals may seek to avoid or evade inheritance tax through various legal and illegal means, such as transferring assets to trusts, offshore accounts, or through complex estate planning strategies. Enforcing compliance and preventing tax avoidance would require robust monitoring and enforcement mechanisms.

c) Valuation of Assets:

Determining the value of inherited assets, especially non-cash assets such as real estate, businesses, and artwork, can be challenging and prone to manipulation. Establishing fair and accurate valuation methods to assess the tax liability would be crucial but could be subject to disputes and litigation.

d) Impact on Family Businesses:

Inheritance tax could potentially impose a significant financial burden on family-owned businesses and farms, which may have high asset values but limited liquidity. This could lead to the breakup or forced sale of family enterprises to pay the tax liability, affecting their continuity and viability.

e) Administrative Capacity:

India’s tax administration already faces challenges in terms of capacity, efficiency, and corruption. Implementing and enforcing a new inheritance tax regime would require additional resources, training, and institutional capacity, which may be lacking or difficult to develop.

Addressing these challenges would be essential for the successful implementation of inheritance tax in India and would require careful consideration of policy design, enforcement mechanisms, and stakeholder engagement.

Conclusion and way forward for having an inheritance tax in India

Moving forward with the implementation of inheritance tax in India would require a comprehensive approach that addresses the challenges while maximizing the potential benefits. Here are some key steps that could be considered:

a) Policy Design:

Develop a well-designed inheritance tax system that balances revenue generation with fairness and efficiency. This includes setting appropriate tax rates, thresholds, exemptions, and valuation methods to ensure that the tax is equitable and not overly burdensome to administer.

b) Stakeholder Engagement:

Consult with various stakeholders, including taxpayers, businesses, legal experts, and civil society organizations, to gather input and build consensus on the design and implementation of inheritance tax. Addressing concerns and incorporating feedback from stakeholders can help improve the legitimacy and effectiveness of the tax system.

c) Capacity Building:

Invest in strengthening the capacity and capabilities of tax authorities to administer and enforce inheritance tax effectively. This includes training tax officials, improving tax administration systems, and leveraging technology for better compliance and enforcement.

d) Anti-Avoidance Measures:

Implement robust measures to prevent tax avoidance and evasion, including strict reporting requirements, enhanced disclosure rules, and penalties for non-compliance. Close coordination with other tax jurisdictions and international cooperation on tax matters can help address cross-border tax evasion.

e) Support for Family Businesses:

Provide targeted support and incentives for family-owned businesses and farms to mitigate the potential impact of inheritance tax on their continuity and viability. This could include tax relief measures, such as deferral or installment payment options, to ease the tax burden on asset-rich but cash-poor enterprises.

f) Monitoring and Evaluation:

Establish mechanisms for monitoring the implementation and impact of inheritance tax, including tracking revenue collections, compliance levels, and distributional effects. Regular evaluations can help identify areas for improvement and inform adjustments to the tax system over time.

g) Public Awareness and Education:

Increase public awareness and understanding of inheritance tax and its rationale. Educating taxpayers about their rights and obligations under the tax system can foster voluntary compliance and reduce misconceptions or resistance to the tax.

By taking a holistic and proactive approach to inheritance tax implementation, India can create a fair and effective tax system that promotes wealth redistribution, economic growth, and social equity.

References:

Practice Questions for UPSC Mains

Topic: Inclusive Growth and issues arising from it (GS Mains Paper 3)

Q. How does the potential reintroduction of inheritance tax in India impact wealth distribution, economic growth, and tax fairness, considering challenges in implementation and stakeholder concerns? (Answer in 250 words)

Introduction:

The potential reintroduction of inheritance tax in India sparks debates surrounding its impact on wealth distribution, economic growth, and tax fairness. While proponents argue it could address wealth inequality, generate revenue, and promote fairness, challenges in implementation and stakeholder concerns present significant considerations.

Impact on Wealth Distribution:

Reintroducing inheritance tax could potentially redistribute wealth by taxing large inheritances, reducing wealth concentration among affluent families.
This may lead to a more equitable distribution of resources, addressing concerns of widening wealth gaps in Indian society.
However, its effectiveness in mitigating wealth inequality depends on the design of the tax system, including tax rates, exemptions, and enforcement mechanisms.
Moreover, the impact on family businesses and farms, which often have high asset values but limited liquidity, needs careful consideration to avoid adverse effects on entrepreneurship and economic stability.

Impact on Economic Growth:

The potential impact of inheritance tax on economic growth is subject to debate. While proponents argue that it could promote meritocracy and discourage the perpetuation of dynastic wealth, opponents raise concerns about its potential negative effects on investment, entrepreneurship, and capital formation.
Family-owned businesses and farms, which constitute a significant portion of India’s economy, may face challenges in meeting tax liabilities, potentially leading to disruptions in operations, job losses, or forced asset sales.
Moreover, the administrative burden and compliance costs associated with inheritance tax could deter business investment and innovation, hampering economic growth prospects.

Impact on Tax Fairness:

Inheritance tax can contribute to tax fairness by ensuring that individuals contribute to society based on their ability to pay, rather than solely relying on earned income or consumption taxes.
It also aligns with the principle of horizontal equity, where individuals in similar economic circumstances are treated equally under the tax system.
However, challenges in implementation, such as tax avoidance and evasion, valuation of assets, and administrative capacity constraints, may undermine its fairness objectives.
Moreover, concerns about double taxation, intergenerational transfer of wealth, and unintended consequences on family dynamics warrant careful consideration in designing an equitable inheritance tax regime.

Conclusion:

The potential reintroduction of inheritance tax in India presents complex trade-offs between its impact on wealth distribution, economic growth, and tax fairness.
Addressing challenges in implementation and stakeholder concerns is crucial to maximizing its potential benefits while mitigating adverse effects on the economy and society.
A well-designed inheritance tax system, informed by rigorous analysis and stakeholder engagement, is essential for achieving equitable and sustainable outcomes.