What is Inheritance tax?

Let us clear one thing - inheritance tax is not applicable in India. Then why are we discussing it? The reason is in the last few weeks, there has been a debate around the re-introduction of inheritance tax in India. However, the discussion is not happening for the first time. The debate sparks up every few years. Here, we discuss everything you need to know about this tax.

What Is Inheritance Tax?

Inheritance tax, also known as estate duty or death tax, is a tax paid on the estate of the deceased. It is collected from the estate before the distribution to the heirs under the Will or the heirs under intestate succession laws. The tax rate under the inheritance law varies from country to country and depends on two main factors:

• The value of the inheritance received
• The relationship to the deceased

History of Inheritance tax

The inheritance tax is not there in India now. It was there before. Let us look at the details. The Estate Duty Act was introduced in India in 1953 to reduce economic disparity by taxing wealth transferred through inheritance. Here are a few important points related to estate duty back then:

• The tax was applied to the market value of all movable and immovable property inherited, including agricultural land.
• It was not levied on the entire estate - there was an exemption limit set by the Act.
• The tax rate was determined by the market value at the time of death.

The tax was abolished in 1985. The reason for this was the high administrative costs and time involved in the collection of estate duty compared to the meager collections that led to its abolition.

When is the inheritance tax levied?

It applies when someone inherits assets from a deceased person, but the timing of when the tax needs to be paid can vary depending on the specific jurisdiction. 

The beneficiary who receives the inheritance is typically responsible for paying the inheritance tax within a specific timeframe set by the relevant jurisdiction. This timeframe could be a few months or even a year after the date of death. Some locations might allow for payment in installments depending on the inheritance amount.

Calculation for Inheritance tax

In India, there is no inheritance tax, as we have discussed earlier. However, to help you understand how it works - let us take the example of France. Many factors determine the final tax amount - we won't go into the details - we keep it simple.

Let us say the total value of the inheritance is €500,000. The beneficiary is the child (direct inheritance). Next, let us assume is there a tax-free allowance of €100,000 for children inheriting from their parents.

• Taxable Amount: €500,000 - €100,000 = €400,000

Now, let's say the applicable tax rate for this amount is 10%.

• Inheritance Tax Owed: €400,000 * 10% = €40,000

So, in this scenario, the inheritance tax owed would be €40,000.

Limitations of Inheritance Tax

Inheritance tax, like any tax system, has its limitations. Let us look at the top three common limitations and challenges associated with inheritance tax:

Double Taxation: One of the primary criticisms of inheritance tax is that it can lead to double taxation. As you would have figured out, it occurs when assets are taxed both during the deceased's lifetime and again upon transfer to heirs through inheritance tax. Most experts argue that this double taxation can reduce the incentive to save and invest, particularly for those who have already paid taxes on their assets.

Wealth Redistribution: While one of the goals of inheritance tax is to promote wealth redistribution and reduce wealth inequality, experts say that it may not always achieve this goal effectively. Wealthy individuals may employ various strategies to minimize their tax liability, such as transferring assets to trusts or making gifts during their lifetime. Additionally, inheritance tax may not capture all forms of wealth, such as assets held in offshore accounts or certain investment types.

Complexity and Compliance Costs: The third issue with inheritance tax systems is that it is complex and administratively burdensome - both for taxpayers and for tax authorities. Determining the value of assets, assessing tax liability, and complying with reporting requirements can be time-consuming and costly. The complexity can lead to errors, disputes, and inefficiencies in the tax system. For this reason, it was abolished in India in 1985.

Inheritance Tax V/s estate tax

You should not confuse inheritance tax with estate tax, and to make sure you don't, let us compare the two in detail. Here is the difference between the two taxes:

Conclusion

As we have seen, inheritance tax is a complex and often contentious aspect of estate planning and wealth transfer. While it serves as a revenue source for governments and promotes wealth redistribution, inheritance tax can also pose challenges for individuals and families seeking to preserve and transfer their assets to future generations. It is not applicable in India, but it may be some time in the future - so you should know about it.