Comeback of the Estate Duty: Tax Policy Implications

THIS ARTICLE WAS WRITTEN BY YASH BHAGWAT, A STUDENT OF NALSAR.

Introduction

The term ‘estate duty’, more often than not, has been interchangeably used with the term ‘inheritance tax’. However, in the context of the United States of America, both the terms have different meanings. Estate duty is a tax levied on the overall assets of a person left behind by him upon his death before any of the assets are inherited by his heirs. On the other hand, inheritance tax, which has never been implemented in India[1], is a tax levied on the heir at the time of inheriting any of the assets left behind by a deceased person. Section 56(2) of the ITA exempts any property received by way of inheritance from being taxed. However, in India, both the terms more or less mean the same. Thus, for the purposes of this article, they shall be implied to mean one and the same. Estate duty was levied in India through the provisions of The Estate Duty Tax Act, 1953 until 1985 when the Act was repealed.[2]

The Central Government is reportedly considering the reintroduction of the inheritance tax on HNIs having net worth over a specified threshold value in the next budget. This tax, which could range from 5% to 10%, will be levied on bequeathed assets, in order to boost revenue of the Government.[3] Anticipating the reintroduction of the Estate duty, many High Net Worth Individuals (“HNIs”) are rushing to protect their assets from being engulfed in the tax net. Reportedly, a majority of them are resorting to transferring their assets to newly-established private family trusts. Estate Planning firms have witnessed a sudden spurt in the number of HNIs opting for family trusts with a new feature of a “Constitution” mandating all family members to behave morally in order to be entitled to have their share of the family wealth. So, whenever the government decides to reintroduce the estate duty or the inheritance tax, wealth entrusted in family trusts would not attract the levy of tax because on the death of a family member, there would be no transfer of ownership but merely a change in the shareholding of the members.

Numerous businessmen, promoters and HNIs are using family trusts as a way to get around the IBC and the guidelines on bad debts and Non-Performing Assets.[4] Further, businessmen are also resorting to forming family trusts in tax havens like Channel Islands in order to circumvent the stringent taxation system of India. This not only leads to loss of tax revenue for the government but also accumulates wealth outside India. In backdrop of the NDA government’s promise of ‘gharwapsi’ of wealth i.e. bringing back wealth stashed outside India, the move of reintroducing the estate duty would most certainly backfire, leading to disastrous consequences. Moreover, even Non-Resident Indians (“NRIs”) are resorting to the formation of family trusts in order to continue investing their wealth in India without attracting taxes in the USA or Europe.[5] Family trusts act as insulators against the provisions of the Foreign Account Tax Compliance Act (“FATCA”) in the USA and of the inheritance tax provisions in Europe. A sale of assets belonging to family trusts is not liable to be taxed and thus, NRIs are creating family trusts and transferring their assets before selling. However, the limitation to family trusts is that they generally hold bank accounts and equity shares, not immovable property. Thus, the transfer of immoveable property to the family trust and then further, from the family trust would still attract stamp duty and income tax and after the introduction of inheritance tax, a tax would be levied on the bequeathal of such immovable assets.

According to a recent survey by Hurun Research Institute, as of July 31, 2017, there were 617 HNIs in India having net worth of more than Rs. 1,000 Crore. While introducing the tax, the government should ensure that it clubs the exemption limits of gift tax with those of the inheritance tax, as is done in most economies, so as to leave no window of tax avoidance open for the HNIs. The Organization for Economic Co-operation and Development (“OECD”), in its report titled “Economic Survey of India” opined that India should gradually cut down on its corporate income tax rate from 30% to 25% while reintroducing the inheritance tax so as to make up for the loss of revenue.[6] Giving due credence to the fact that the concentration of wealth in India is in the hands of few HNIs, the OECD backed the levy of inheritance tax while providing for a high exemption threshold.

Pros and Cons of Inheritance Tax

In the absence of inheritance tax, a person who has amassed wealth disincentivizes his progenies from contributing to the economy through working and earning their living. The amassed wealth attains a sense of perpetuity which will keep flowing through to future generations. Inherited wealth ensures that the descendants of the rich remain rich. By taxing such inherited wealth, a proportion of the same would be received by the Government which could be utilised for the benefit of the masses, thereby achieving one of the prime objectives of any tax policy i.e. redistribution of income.

On the other hand, it can also be argued that the deceased person had already paid income tax over the earnings from his estate, capital gains tax (if applicable) and an annual wealth tax over the possession of assets (until the Wealth Tax Act, 1957 was abolished in 2015). Thus, taxing his assets at the time of inheritance could lead to not just double, but multiple taxation. Non-profit associations like the Federation of Indian Chambers of Commerce and Industry (“FICCI”) and Confederation of Indian Industry (“CII”) are of the view that inherited tax is essentially a phenomenon typical to the Western countries struggling to boost their growth rate.[7]

Roughly, from the period of 1950s to 1980s, the direct taxation system of India consisted majorly of Income Tax, Wealth Tax, Gift Tax and Estate Duty. These taxes were introduced with the chief social objective of redistribution of income and wealth. Thus, not only was the income and wealth acquired by a person taxed, but the transfer of such income or wealth in the form of gift or bequeathal was also taxed. The acts governing estate duty, gift tax and wealth tax have been repealed in the years 1985, 1998 and 2015 respectively. This clearly shows the intent of the government towards simplifying the direct taxation system by making it less burdensome and the reintroduction of the inheritance tax would be an unnecessary contradiction to the same. The major purpose behind the rationalization of the direct tax system was to motivate productive undertakings simplifying laws, moderating rates, reducing litigation, etc. and to prevent black money and encourage voluntary compulsion by removing the disincentives to earning and acquiring income and wealth. The repulsion of the acts has clearly served the purpose since the amount of tax collected, instances of voluntary compliances and the tax base have increased significantly despite the reductions in tax rates over the years.

One of the major reasons behind the abolition of estate duty was that the cost of administration involved in inheritance tax was higher than the actual tax collected, because of the practical difficulties in valuing assets, complex technicalities and ambiguities in the statute, rampant litigation and the allied litigations costs, etc. The government has also had recent experiences with the Fringe Benefit Tax and the Wealth Tax that the time, effort and costs involved in the administration of these taxes is not correspondingly proportionate to the tax collection, thereby leading to their repulsion. Thus, learning lessons taught by its past mistakes, the government should refrain from making them again.[8]

If a high tax rate is imposed on the estates of deceased persons, it would impose an unnecessary burden on that part of the population which is already a major contributor to the direct tax collection in India. It would also discourage savings and would further drive away a considerable amount of quintessential capital abroad. In light of the world economic slowdown, the tax structure should be such so as to encourage businesses to locate in India. History suggests that if tax rates are lower, businessmen and investors feel incentivised to undertake productive endeavours and invest in them. In an attempt to boost revenue through taxes, the government shall not gamble with the levels of economic activity in the country

The argument in favour of the reintroduction that ‘the wealth amassed by the first generation is being taken advantage of by the second generation without putting any efforts or contributions to the economy’ holds water on the grounds of logic. Also, the view that introducing the estate duty would reduce intra-generational inequality and promote inter-generational equity stands firm on grounds of equity.[9] Further, due credence has to be given to the fact that the government has acknowledged the possibility of economic unrests in opposition of the concentration of wealth in the hands of a few (for e.g. Naxalite Movement)[10]. However, in the Indian context, it needs to be understood that most of the wealthy businesses are family-run and therefore, the imposition of estate duty could potentially lead to a break-up of the family estate and thus, of the family business which could significantly affect the economic growth. Further, practical realities have to be taken into consideration as well. Some of the developed nations where inheritance tax has been imposed have experienced that in order to discharge the inheritance tax, heirs have had to sell off the inherited estate itself.

Ever since the dawn of the 20^st century, major economies like New Zealand, Australia, China, Canada, Norway, Singapore, Russia, Sweden, Hong Kong and the Gulf Co-operation Council (“GCC”) countries[11] have either done away with the inheritance tax or never introduced it. On the other hand, developed nations like the USA[12], UK, Japan, Switzerland, Germany, France, Spain, Netherlands and Belgium still impose estate duty. The reason behind the effectiveness of the estate duty in these countries is that their social security systems and retirement plans and schemes are strong enough to bear the consequences of such a tax on the society. Social security system is nothing but a distant reality in India and thus, the mere introduction of a tax with the same name as that in developed nations won’t result in economic stability. Along with the introduction of the inheritance tax, the government would have to work on building a social security system so as to release the burden from the taxpayer who naturally tends to accumulate wealth in order to deal with potential future uncertainties and ensure financial security of future generations. In this globalised era wherein businessmen and investors have a plethora of options to locate their businesses and investments in, reintroducing the estate duty by going against the international trend would not reflect in a good fashion in the minds of businessmen and investors looking to operate in India. It could have the effect of damaging the achievements of the ‘Make in India’ Campaign.

It was concluded in a recent study conducted in Sweden that “far from increasing inequality, inheritance tends to reduce it.”[13] Thus, taking into consideration the international wave of countries attempting to do away with the inheritance tax and the various contradictory implications and ill-effects that its reintroduction could have, the government should refrain from making yet another potential bad policy decision of bringing back the estate duty. A cost-benefit analysis of the proposed reintroduction results in the definite costs clearly outweighing the expected benefits. Alternatively, if the revenue boost through taxation is an indispensible requirement, the government could very well create further tax slabs in the highest income level (i.e. income above Rs. 10 lakh per annum). For instance, increasing the income tax rate for people earning above Rs. 1.5 crore per annum from 30% to say 33-35% would hardly have an effect on the cost of administration but would fetch the same amount of tax (more or less) as proposed to be earned from estate duty. France resorted to creating a new and higher income tax slab for top earners and so did the USA by increasing the tax rates for people earning over $400,000 per annum. However, while doing so, concrete steps would have to be taken to ensure that the recently built culture of voluntary compliance by assessees remains unharmed.

Conclusion

In conclusion, it can be said that though the government aims at serving a noble cause through the reintroduction of estate duty, it might just not be the right time for the estate duty to make a comeback. Instead of resorting to a trial and error method of finding a sure-short mode of revenue collection, the government must divert its focus and resources on building a sturdy taxation system which would be able to absorb the implications of economic fluctuations.

[1] Karan Batra, Inheritance Tax in India and Other Taxes on Ancestral Property, Chartered Club, available at: http://www.charteredclub.com/inheritance-tax/

[2] Gautam Nayak, Don’t bring back estate duty, but tax incomes above Rs. 1 Cr, Live Mint, Jan 09, 2013, available at: http://www.livemint.com/Money/1xwsslAXu59wIPyuwVtASI/Dont-bring-back-estate-duty-but-tax-incomes-above-1-cr.html

[3] Sachin Dave, Inheritance Tax on HNIs likely to be reintroduced, Economic Times, Oct 11, 2017,  available at: https://economictimes.indiatimes.com/news/economy/policy/inheritance-tax-on-hnis-likely-to-be-reintroduced/articleshow/60946816.cms

[4] Sachin Dave, Spooked by inheritance tax fears, Indian HNIs are opting for family trusts, Economic Times, May 11, 2017,  available at: https://economictimes.indiatimes.com/wealth/tax/spooked-by-inheritance-tax-fears-indian-high-net-worth-individuals-are-opting-for-family-trusts/articleshow/58617989.cms

[5] Sachin Dave, Tax-savvy American NRIs use family trusts to insulate Indian assets, Economic Times, Jun 24, 2017, available at: https://economictimes.indiatimes.com/news/economy/policy/tax-savvy-american-nris-use-family-trusts-to-insulate-indian-assets/articleshow/59292171.cms

[6] India should cut corporate tax, go for inheritance levy: OECD, Economic Times, Feb 28, 2017, available at: https://economictimes.indiatimes.com/news/economy/foreign-trade/india-should-cut-corporate-tax-go-for-inheritance-levy-oecd/articleshow/57387723.cms

[7] ET in the classroom: Inheriting a tax fortune, Economic Times, Jan 21, 2013, available at: https://economictimes.indiatimes.com/slideshows/investments-markets/et-in-the-classroom-inheriting-a-taxing-fortune/why-is-the-government-contemplating-an-inheritance-tax/slideshow/18110517.cms

[8] Shailesh Monani, It’s a bad time to bring back estate duty, DNA Times, Feb 19, 2013, available at: http://www.dnaindia.com/mumbai/report-it-s-a-bad-time-to-bring-back-estate-duty-1801388

[9] Adess Singh, Why India needs an Inheritance Tax, Your Story, available at: https://yourstory.com/2017/07/india-inheritance-tax/

[10] 0.01 % of the population of India holds 33% of the total wealth in India. 182 cities across 20 Indian states have witness Naxal movements against the issue of concentration of wealth.

[11] Should India reintroduce Inheritance tax? Here are 4 expert views, Economic Times, Oct 16, 2017, available at: https://economictimes.indiatimes.com/wealth/tax/should-india-reintroduce-inheritance-tax-here-are-4-expert-views/articleshow/61078197.cms

[12] The USA is reportedly considering scrapping the estate duty.

[13] Ed Conway, Scrapping inheritance tax is good for all of us, The Times, Dec 1, 2017, available at: https://www.thetimes.co.uk/article/scrapping-inheritance-tax-is-good-for-all-of-us-m6hblw2mv