What is Inheritance Tax?
The discussion of inheritance tax is a necessary but sensitive one. This cess unfortunately only exists and is fueled by demise. However, as finance professionals, we need to understand and discuss the succession of property and finance to facilitate stability for the survivors.
This tax primarily ensures that the transfer of ancestral property to the successor named in the property owner’s will is properly taxed. Many countries like the USA, UK, Spain, Netherlands, Belgium, etc. have a system in place where the heir must pay Inheritance tax BEFORE inheriting any property from their deceased patron.
Does India have an Inheritance Tax?
Interestingly enough, India does not currently have a tax on property or amount inherited in relation to the contemplation of death as this is exempted under Section 56 (ii) of the Income-tax Act, 1961. The Inheritance or Estate tax was abolished by the Rajiv Gandhi administration in 1985. The reason for its initial introduction was to ensure uniform distribution of wealth and for the revenue department to document asset ownership.
The idea behind the tax was feasible on paper. However, the finance minister of the Rajiv Gandhi administration, Mr. V.P. Singh believed that the tax was not serving its purpose of reducing the wealth gap. The cost of accounting for and verifying assets along with compliance and implementation costs, left this tax costing the revenue department more than it had come in.
So, how do we tax Inheritance?
As mentioned above, we don’t. Instead, the income earned on inherited property is taxed. Even if the inherited asset is not property or not tangible, the asset is not taxed on inheritance. This can primarily be in two forms: Rental Income and Capital Gain on the subsequent sale of inherited property.
When a property is inherited by the heir, the property title is now in his / her name, and thereby the income from the same also goes to them. They must declare the said income and pay taxes on the property income. For example, Ms. X holds a house property in
Chennai and has declared Mr. Y as her heir. Post the demise of Ms. X, Mr. Y inherits the house property which has been leased out to a family. The rental income to Mr. Y from the said family will be taxable under Section 24 of the Income-tax Act, 1961.
Similarly, sale from house property attracts either short or long-term capital gains depending on the duration for which the said property was held. Short and long-term gains are taxable under Section 45 of the Income-tax Act, 1961. Keeping in theme with our previous example, suppose Mr. Y proceeds to sell this house property to Mr. Z after holding it for say, 3 years. Since this is over 12 months, it attracts long-term capital gains tax and the same will be disclosed in his income tax return.
Types of Income on Inherited Assets
Future of our Estate tax
In light of the recent pandemic of COVID-19, economists suggest introducing an inheritance tax to ensure equitable distribution in times of a bio-disaster. Tax officials want a tax that goes as high as 55% because a massive portion of our GDP belongs to the “1%” whereas the others range from the upper-middle class to those in abject poverty. The idea is to increase the tax base and bring about a reduction in tax rates as the gap between taxpayers is bridged.
Realistically, the Indian government has always stated the difficulty in the collection of taxes. Ultimately, it has been made apparent that even though other countries have estate taxes, property inherited in India does not amass the high value that property inherited abroad has. Reintroduction of the tax will depend on how beneficial it is to the tax base and how feasible the reporting and collection overall are.