The ABC of Inheritance Tax in India

Let’s take you back to the year 1953 when India was included in several reforms that were introduced, abolished, or changed! For instance, the creation of Indian airlines, Air India getting nationalized, the introduction of inheritance tax/estate duty, etc. There were several kinds of taxes that have been worked on, abolished & changed.

Inheritance taxes or estate duty was levied against a particular asset, like the ancestral property during the time of its inheritance. 

The question is, is inheritance tax continued in India, like in the countries?

What is an inheritance tax in India?

Inheritance tax, also known as estate duty, was a tax levied on the total value of the deceased’s estate before distribution to the heirs. In India, inheritance tax was abolished in 1985. Currently, India does not impose any direct inheritance tax on the property or assets inherited. However, the recipients of the inheritance may be subject to other taxes, such as income tax on any income generated from the inherited assets and capital gains tax upon the sale of inherited property. It is essential for heirs to understand these implications to manage their inherited assets effectively and ensure compliance with Indian tax laws.

Understanding Inheritance Taxes

As stated earlier, inheritance taxes, also known as estate taxes, were abolished in India in 1985. However, understanding their concept is crucial for comprehending the broader financial landscape. Although there is no direct inheritance tax, the income generated from inherited assets is taxable. For example, if you inherit a house from a deceased relative and later rent it out, the rental income is taxable under your income. Similarly, if you inherit shares and earn dividends, those dividends are taxable. If you sell the inherited property, capital gains tax will apply based on the property’s value increase since the original purchase. Thus, while India lacks an inheritance tax, related tax obligations remain significant.

Limitations of Inheritance Tax

Inheritance tax, while intended to address wealth transfer, has several limitations. In many jurisdictions, including India, inheritance tax was abolished due to concerns about its impact on families and the economy. One limitation is that it can create liquidity issues for heirs who may need to sell assets to cover the tax. Additionally, it may discourage savings and investments if individuals perceive a significant tax burden on their estate. Inheritance taxes can also be complex to administer and often involve detailed valuations of assets, potentially leading to disputes and additional costs for families.

Will the history of inheritance tax be repeated? 

During the Rajiv Gandhi Government in 1985, an inheritance tax was abolished in India. Despite its noble intentions, V.P. Singh, the then finance minister, believed that it had failed to bring about an equilibrium in society and reduce the wealth gap. 

A few rumored economists have advocated for the return of Estate duty as they see it as a viable tool to combat rising inequality, beat the deficit, and boost revenues.

Even Finance Minister Arun Jaitley has denied the reintroduction of this tax as he says that the revenue generated by it will be dismal because Indians do not inherit assets of the same value as those in developed countries. Thus, government sources have repeatedly denied these claims.

Inheritance tax is observed in many countries, such as the USA, UK, Netherlands, Spain, and Belgium, and China even introduced rules for inheritance tax back in 2002, but the idea was opposed strongly and could not be implemented.

Most developed countries that practice inheritance tax levy a maximum rate of as high as 80% on the net value of the assets passed on to legal heirs after the owner’s demise but these high rates are offset by the fact that most of these countries provide a strong form of social security to their citizens. 

Income tax implications on inheritance

A deceased individual’s property would pass on to his legal heirs upon his death. There is no doubt that this is a transfer without any consideration in return. Therefore, it would qualify as a gift for tax purposes.

Under the Income Tax Act, of 1961, the transfer of assets by will or inheritance is specifically excluded from gift tax. Consequently, the property received through inheritance is not subject to taxation.

Calculation for Inheritance Tax

Calculating the tax on inheritance involves determining the value of the deceased’s estate and applying the relevant tax rates. Typically, the estate’s value is assessed based on assets like property, investments, and cash, minus any debts or liabilities. Tax rates can vary, often with progressive brackets depending on the estate’s value. For instance, a lower rate might apply to smaller estates, while larger estates face higher rates. Exemptions and deductions, such as those for certain assets or beneficiaries, can also affect the final tax liability. Proper valuation and understanding of applicable tax rules are essential for accurate calculation.

Tax on subsequent sale

Inheritor taxes depend on how much capital gain they gain from selling their ancestral property. There are two clauses involved here:

• The gain from the sale of ancestral immovable property is considered long-term gains (LTCG) if it has been held for more than two years from the date of acquisition.
  
  With indexation, long-term gains accrued in this manner are taxed at 20.8%. With indexation, the price at which the property was purchased is recalculated to account for inflation. By income tax regulations, this calculation is made. 
• The gains on immovable property are considered short-term gains (STCG) if the inheritors hold them for less than 24 months from the date of inheritance. Based on the income tax rules, the inheritors pay a slab rate.

All laws that govern the sale of inherited immovable property must be familiar to the inheritors. The capital gains tax should be calculated based on the purchase price, indexation costs, and all other relevant information.

If heirs reinvest the amount within certain timeframes, they can avoid paying capital gains tax on the gain. They can also invest in capital gains bonds if their capital gains tax is high. The 1961 Income Tax Act allows a maximum investment of Rs. 50 lakh per year under section 54EC.

Inheritance tax on movable assets

Unless the inheritors sell the inherited movable assets, there is no tax liability. In addition, the following requirements must be met:

• Inheriting bank accounts –
  Inheritors must change the account holder’s name after inheriting the account. As long as the inheritors are legal heirs to the deceased, they are permitted to withdraw the requisite funds in accordance with accepted legal guidelines. 
• Bank lockers –
  In the case of a bank locker, the contents are transferred to the inheritors. Inheritors are not required to pay any taxes because bank items are provided against some form of guarantee. 
• Fixed deposits –
  In this situation, the inheritors have the option of allowing the fixed deposits to mature and then using them or closing them before they mature. 
• Stocks and shares inherited –
  The dematerialized form is inherited by the inheritors or joint nominees, who pay income tax based on the revenue earned. 
• Life Insurance Policy:
  An individual’s life insurance policy matures after he or she passes away. To claim the funds, nominees must fulfill certain formalities and provide specific information. 
• Vehicles inherited –
  The inheritors must arrange for the vehicle/s to be transferred into their names. For this, they must apply at the state’s regional transport office (RTO).