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    Tuesday, December 25, 2007

    Estate tax: Advantage India?


    Will India be the next tax haven? Unlikely, but interesting

    India’s economic growth and booming capital markets have generated unprecedented wealth for Indian promoters. Suddenly, India has billionaires coming out of its ears, more than Japan by one count. Yet, India’s entrepreneurs are lucky: they can pass most of their wealth to their children without too much hindrance.


    Unlike many advanced market economies, India has no estate tax, or estate duty as it was known in India. Estate duty was introduced in 1953 and was abolished way back in 1985, when V P Singh was the finance minister. It is not payable on deaths occurring after March 16, 1985.

    World wide, the estate tax, also sometimes called the death tax, is very much a reality. Wherever it is levied, it is usually payable on the value of the accumulated savings (by way of assets accumulated) of a deceased person. The policy intention is to bring about inter-generation equity, i.e., to ensure the children of the rich don’t have too much of an advantage in life compared to the less privileged.

    On the other hand, many tax experts slam the estate tax — known as the Inheritance Tax in the UK — as a-hard-to-collect levy, which penalises savings and investment. It also encourages tax avoidance by way of creation of trusts and shell companies to which property and other assets can be transferred.

    Tax rates vary widely across countries. Data collated for 2005 by PricewaterhouseCoopers for 50 countries shows Japan with a top rate of 70%. South Korea’s rate is 50% followed by the US (46%), and France and UK with 40% each. On the other hand, many countries, including India, do not levy estate tax. According to the PwC study, the 24 countries with no estate tax include China, Russia, Australia and Malaysia.

    In virtually all countries with estate tax, the nominal rates usually apply only for assets above a certain exemption limit, which is usually set high enough to exclude a large chunk of taxpayers. In the US, for instance, the estate tax is payable after an exemption of $2 million.

    The US law is, in fact, very complicated. As part of President Bush’s 2001 tax cuts, the basic exemption limit was raised from $1 million in 2001 to $2 million, at which level the 46% rate kicks in. In 2010, the estate tax is repealed for a year. Then after 2011, the basic exemption drops to $1 million and the tax rate rises to a rather high 55%. There are jokes about the murder rate for rich people shooting up in 2010.

    The June 2006 Tax & Budget bulletin of the libertarian Cato Institute states, “The estate tax is probably the most-inefficient tax in the US. It has a high marginal rate and is very difficult for the government to administer and enforce. It has also created a large and wasteful estate planning and avoidance industry. The industry overflows with...lawyers and accountants... creating financial structures to minimise the tax burden using trusts, life insurance and private foundations.” The institute wants the US to scrap the estate tax, which accounts for just over 1% of federal tax revenues.

    In the UK, the inheritance tax is payable if the taxable value of the estate is above £285,000 (2006-07 tax year) according to the British government’s website. The term ‘Estate’ is defined as “broadly speaking...everything you own at the time of your death, less what you owe,” according to the website. In addition, it might be payable on assets given away by the deceased during his/her lifetime, including property, money and investments. The tax kicks in over the threshold value.

    The main argument in favour of estate tax is that it levels the playing field between the rich and the poor. The main argument against is that it discourages savings and investment, and hence capital accumulation. Obviously, a high rate of estate tax is a disincentive since a person would find it difficult to pass on his wealth to his descendants.

    Further, since the tax is levied on the net value of assets, not on income, it can create a major liquidity problem for the inheritor who has to pay. This is because the tax is a lump-sum payment that may exceed revenues from a particular set of assets. Indeed, it can potentially create an incentive to liquidate the business.

    In India, estate duty was abolished partly because it amounted to double taxation, since stamp duty is in any case levied on transfer of property to heirs. Stamp duty is currently between 7-9% in most states and is in some way a quasi-estate duty. The Centre wants states to bring it down to the 4%-6% range. A stamp duty is, however, only a rough proxy for estate duty since it is payable on all property sales/transfer while the latter is payable only on the death of a property owner.

    In general, all taxes which are levied on assets, such as estate tax or the wealth tax tend to result in the creation of complex tax avoidance structures. Sweden’s new centre-right government has recently decided to scrap the country’s 1.5% wealth tax, which in that country is levied on all persons with wealth exceeding $2,00,000.

    The tax is estimated to have led to billions of dollars of capital flight. Ingvar Kamprad, the owner of iconic furniture maker Ikea and Sweden’s richest man controls his wealth, estimated at over $20 billion, through foundations based outside Sweden.

    Enormous donations to foundations with a charitable purpose, most famously by Warren Buffet and Bill Gates, may well be part of the Christian tradition but high estate tax is undoubtedly a major driver. Typically, the children of the wealthy tend to be associated with the trusts set up by mega creators of wealth like Buffet or Gates. In both Europe and the US, broadly speaking centre-left parties tend to support estate taxes while centre-right parties (such as Republicans in the US and Tories in Britain) tend to favour their abolition.

    Can India attract tax tourists from the US or other high estate-tax countries? That’s right now a theoretical possibility, experts feel, given the poor physical infrastructure and lack of adequate legal framework, including the absence of complete capital account convertibility.

    Also, it is far from clear what view the IRS, the US government’s famous tax arm, will take of persons relocating to India. The US claims to tax income generated worldwide by all its citizens, though in practice major companies use tax havens such as the Cayman Islands to minimise the dues payable to Uncle Sam. Still, it’s a possibility that India can exploit in the future as it gets richer.

    (With inputs from Bakul Chugan)

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