Can inheritance tax alter succession planning in India's family-owned businesses?

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An inheritance tax, if levied in India, may certainly alter succession planning among business families, but the question is whether it will really favour a redistribution of wealth. It is rather complex, in the already complicated world of taxation systems.

In the heated election period, there is a political debate brewing on inheritance tax in India, and its merits favouring wealth equality. Amidst the mudslinging, we explore if inheritance tax is a silver bullet or can it enhance equality of opportunity by reducing wealth gaps.

Prashanth Shivadass, partner, Shivadass & Shivadass Law Chambers, says inheritance tax in India would only result in more litigations, since every individual receives even less money than what was originally proposed. “However, large family business or corporates can structure their estates during the lifetime of the individual itself. The other (lesser liked option) is to spend earnings or donate to charitable causes.”

Inheritance tax is paid by the beneficiary for inheriting a property or asset from a deceased person on the value of the inheritance. This taxation can be as high as 55 percent, depending on the country.

According to Bijal Ajinkya, partner, Khaitan & Co, family disputes on succession have no relevance to the levy of inheritance tax. If a family member is unhappy about his/her succession, then they are bound to dispute it, irrespective of whether inheritance tax is levied or not.  

“Inheritance tax does not apply in India. India used to have an estate duty until 1985, at which point in time it was abolished due to a high administrative costs of collecting the same. India has a moderate to high level of income tax. We do not have a wealth tax or an estate duty,” Ajinkya adds. India had a wealth tax, which was abolished in 2015, but there remains a gift tax.

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What is inheritance tax?

Inheritance tax is a phrase that is synonymous to ‘death tax’ or ‘estate duty’, which is levied on the estate or wealth of a deceased person. It was basically a tax on the market value of the estate, before it was passed down or inherited by family members, after the death of a person.

When wealth tax did exist, estates were mostly in the hands of a few families. To ensure that the government received adequate revenue from these estates, a tax was collected from them before being inherited by the family. “Largely, estate duty/inheritance tax was frowned upon, given that it was time consuming and involved high costs. There was also a lot of litigation on the value imposed as estate duty (which would be calculated basis the market value of the property at the time of person’s death subject to deductions),” Shivadass explains.

The reason behind imposing an inheritance tax is to ensure that the next generation is not left with excessive wealth that they are no longer required to engage themselves in productive work and hence become harmful effects on society. “The philosophy behind imposition of this tax is not to add to the revenue of the exchequer,” Ajinkya says.

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She elaborates that if a developing country, which requires both capital and industry for its economy to develop, is saddled with an inheritance tax, it could lead to excessive spending by a generation that has less of a savings mindset; it can also curb entrepreneurship, and lower the need to generate capital and employment, which is required to stir the economy. Most developing countries do not have adequate social security and a concessionary or free health care system, and if spending habits are increased, it would lead to a situation where a middle-aged, working-class population is sandwiched between the aged and the young, both of whom it is providing for.

“This could also lead to a brain drain of human capital, who would rather move to a country which does not have an inheritance tax, where they could build wealth,” Ajinkya explains.

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The national health service (NHS) collapsing in the UK and Japan struggling with a high level of aged population is proof of the ill effects of a high tax regime, says Ajinkya. Another downside of imposing an inheritance tax in a developing country is that individuals will stop being transparent about their wealth and would look at structures to mask their wealth, which is what India witnessed in the pre-liberalised era of high taxes. “This leads to a dishonest economy,” she remarks.

Only a few developed countries levy inheritance tax. Among others, the United States, Canada and the UK are some countries that impose it. Most legislations across the world have similar approaches to the manner of imposing tax and the rates range between 5 and 60 percent. The UK has an inheritance tax basis domicile status of the individual. It is, however, levied on the worldwide estate of the individual if they are domiciled or residents of the UK. In the UK and the USA, the rate is around 40 percent, with some level of exemption.

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Economic implications

“The net beneficiary of inheritance tax is the exchequer, and the loser would be the family members who have seen their parents work hard to earn the wealth and raise the standard of living for their families and other business stakeholders, like their employees,” Ajinkya says.

Explains Shivadass that if one were to apply the pre-1985 Indian inheritance law with 85 percent tax when an individual passes away, on a Rs 100 property (located in India and passed on to the individual’s heir) and assuming there were no deductions (funeral expenses, debt etc) Rs 85 will be paid as inheritance tax and the heir will get Rs 15.