TAXATION AND SUCCESSION

History of Inheritance Tax in India - Inheritance tax is a type of tax which is levied on the income earned by an individual from his/her ancestral property. In case of properties that are equally divided among all the siblings, the tax is equally levied on the inheritors. Also popularly known as estate tax or estate duty, Inheritance tax was a tax that was levied against a particular asset during the time of its inheritance.

Inheritance tax is no longer levied in India and was abolished during the time of the Rajiv Gandhi Government in 1985. Though its intentions were noble, the then finance minister, V.P. Singh was of the opinion that it had failed to bring about an equilibrium in society and reduce the wealth gap. During its stay, inheritance tax or estate duty was levied from the period between 1953 and 1985.

What is Inheritance Tax - It is a given that one’s property and assets (including ancestral ones) get passed on to their legal heirs – children, grandchildren or wards – after he/she passes away. In many countries, the heir must pay Inheritance Tax for inheriting any such property or assets from your parents or grandparents or any other relative or friend. In India, however, the concept of levying tax on inheritance does not exist now. In fact, the Inheritance or Estate Tax was abolished with effect from 1985.

Income tax implications on inheritance - In the event of death of an individual, properties belonging to the deceased would pass on to his legal heirs. This event, no doubt, is a transfer of an account without any consideration in return. Hence it could qualify as a gift for the purpose of income tax. However, provisions of Income tax Act, 1961, clearly exclude a case of transfer under a will or inheritance from the purview of gift tax. Accordingly, law does not provide for taxation of property received by way of inheritance.

Tax on income from inheritance - Many a time, the inherited property is a source of income - rent, interest etc. - to the owner. When the heir becomes the owner, the income goes to him. So, the new owner must declare this income and pay taxes accordingly.

All Inherited Assets Are Not Ancestral Property

Not all properties that you inherit can be termed as ancestral property for tax purposes. Ancestral property is defined as one which a person inherits from any of three immediate male ancestors - father, grandfather and great grandfather. Properties inherited from any person apart from these three relations are not considered as ancestral properties, according to the Income-tax Act, 1961. Until 2005, only male members had rights over ancestral property, but after amendments to the Hindu Succession Act in 2005, even women enjoy equal rights over ancestral property.

Legal representatives - Section 159 of Income Tax Act

When a person dies, the assessment of his income pertaining to the period prior to his death would be pending. Courts held in the past that an assessment cannot be made on a dead person and, if so made, would be a nullity in the eyes of law . At the same time, however, it would be unjustifiable to say that upon death of a person, the tax department cannot collect taxes on the income that he had earned prior to death and in respect of which assessments are pending, or even filing of the return may be pending for the last one or two assessment year(s).

What Section 159 Says - Legal representatives

159. (1) Where a person dies, his legal representative shall be liable to pay any sum which the deceased would have been liable to pay if he had not died, in the like manner and to the same extent as the deceased.

(2) For the purpose of making an assessment (including an assessment, reassessment or recomputation under section 147) of the income of the deceased and for the purpose of levying any sum in the hands of the legal representative in accordance with the provisions of sub-section (1), -

(a) any proceeding taken against the deceased before his death shall be deemed to have been taken against the legal representative and may be continued against the legal representative from the stage at which it stood on the date of the death of the deceased;

(b) any proceeding which could have been taken against the deceased if he had survived, may be taken against the legal representative; and

(c) all the provisions of this Act shall apply accordingly.

(3) The legal representative of the deceased shall, for the purposes of this Act, be deemed to be an assessee.

(4) Every legal representative shall be personally liable for any tax payable by him in his capacity as legal representative if, while his liability for tax remains undischarged, he creates a charge on or disposes of or parts with any assets of the estate of the deceased, which are in, or may come into, his possession, but such liability shall be limited to the value of the asset so charged, disposed of or parted with.

(5) The provisions of sub-section (2) of section 161, section 162, and section 167, shall, so far as may be and to the extent to which they are not inconsistent with the provisions of this section, apply in relation to a legal representative.

(6) The liability of a legal representative under this section shall, subject to the provisions of sub-section (4) and sub-section (5), be limited to the extent to which the estate is capable of meeting the liability.

Section 159 was inserted in the Income-tax Act, 1961 to enable assessment of income of a person who was alive during the relevant financial year but had died before filing the return of income or before the income was assessed.

This section provides that when a person dies, his legal representatives shall be liable to pay any tax or other sum which the deceased would have been liable to pay if he had not died “in the like manner and to the same extent” as the deceased.

Thus, there would be separate assessments of income in the hands of the legal representative which he has earned in his personal capacity and that which the deceased had earned prior to his death. The two cannot be assessed as part of the same return of income of the legal representative.

Consequently, therefore, arrears of tax of deceased cannot be adjusted against refund due to the legal representative in his individual capacity.

Liability Of The Representative Assessee - A legal representative is deemed to be an assessee for the purposes of the Act by virtue of section 159(3).The liability of the representative assessee, however, is limited to the extent to which the estate is capable of meeting the liability and it does not extend to the personal assets of the legal representative.

If, however, the legal representative has disposed of any assets of the estate or creates charge thereon, then he may become personally liable. In such cases also, the liability will be limited to the extent of the value of the assets disposed of or charged. A legal representative gets assessed in the PAN of the deceased, but in a representative capacity.

Taxation on Income earns after the date of death but prior to the date of distribution - Section 168 deals with this income - The above provision deals with taxation of income of the deceased in respect of the period prior to the date of death, questions arise as regards taxing of the income that the estate of the deceased earns after the date of death but prior to the date of distribution of the assets of the deceased amongst the legatees.

What Section 168 Says - Executor

168. (1) Subject as hereinafter provided, the income of the estate of a deceased person shall be chargeable to tax in the hands of the executor,-

(a) if there is only one executor, then, as if the executor were an individual; or

(b) if there are more executors than one, then, as if the executors were an association of persons; and for the purposes of this Act, the executor shall be deemed to be resident or non-resident according as the deceased person was a resident or non-resident during the previous year in which his death took place.

(2) The assessment of an executor under this section shall be made separately from any assessment that may be made on him in respect of his own income.

(3) Separate assessments shall be made under this section on the total income of each completed previous year or part thereof as is included in the period from the date of the death to the date of complete distribution to the beneficiaries of the estate according to their several interests.

(4) In computing the total income of any previous year under this section, any income of the estate of that previous year distributed to, or applied to the benefit of, any specific legatee of the estate during that previous year shall be excluded; but the income so excluded shall be included in the total income of the previous year of such specific legatee.

Explanation. - In this section, "executor" includes an administrator or other person administering the estate of a deceased person.

This section essentially provides that the income of the estate of a deceased person shall be chargeable to tax in the hands of the executor to the estate of the deceased.

The executor shall be assessed in respect of the income of the estate separately from his personal income.

Thus, there would be a separate PAN required for filing the return of the executor. Executor shall be so chargeable to tax u/s. 168 upto the date of completion of distribution of the estate in accordance with the will of the deceased.

If the estate is partially distributed in a given year, then, the income from the assets so distributed gets excluded from the income of the estate and gets included in the income of the legatee.

Legatee is chargeable to tax on income after the date of distribution. Even if the executor is the sole beneficiary, it does not necessarily follow that he receives the income in latter capacity. The executor retains his dual capacity and hence, he must be assessed as an Executor till the administration of the estate is not completed except to the extent of the estate applied to his personal benefit in the course of administration of the estate .

This section applies only in case of testamentary succession, i.e. when the deceased has left behind a Will. In cases of intestate succession, the income from the assets earned after the date of death becomes assessable in the hands of the legal heirs as “tenants-in-common” till the assets of the deceased are distributed by metes and bounds.

The section provides that the executor is assessable in the status of “individual”. If, however, there are more executors than one, then, the assessment will be as if the executors were an AOP.

How Ancestral Property Is Taxed 

When a person inherits ancestral property, no tax liability arises at the time of inheritance, as India does not levy an inheritance tax at present. However, in case the inheritor decides to sell the inherited property, any capital gains earned on the sale will be taxable in his or her hands.

Capital Gains Tax on Sale of Inherited Property - The capital gains taxability in respect of property depends upon the period of holding. If the property is held for an aggregate period of more than 24 months from the date of acquisition, any gains at the time of sale of such property is termed as long-term capital gains (LTCG). 

If the aggregate period of holding is less than 24 months, gains from the sale of such property is termed as short-term capital gains (STCG). While LTCG is taxed at the rate of 20.8% (including cess) with indexation, STCG is taxed at the slab rate applicable to the assessee.

The duration for which the original buyer and the inheritor held the property will be taken into consideration. So, even if an inheritor inherited an estate only last year but it was purchased by the original buyer five years ago, he/she will still be required to pay LTCG tax when selling the inherited property.

LTCG Exemption - The tax liability on the sale of inherited property can be substantial. However, there are two different ways in which you can get LTCG exemption. You have the option to invest the LTCG in the construction of new property within three years from the date of sale or purchase a new property within two years from the date of sale.

The other option is to invest in Rural Electrification Corporation (REC) or National Highway Authority of India (NHAI) bonds. These bonds are specifically created to help people get LTCG tax exemption and are also known as capital gain bonds.

An NRI can inherit property in India under the Foreign Exchange Management Act (FEMA), and no tax will be levied on inheritance.

Tax On Inheritance Of Movable Assets

a) No tax is levied on the movable assets, unless the legal heir, nominee or the joint owner decides to sell them. However, certain formalities must be fulfilled by the inheritance owner in case of receiving movable assets.

b) In case of inheriting a bank account, you must change the account name to Account Holder Deceased. If you are the nominee, survivor or legal heir, then you will be credited with the pipeline flow to make withdrawals from the account.

c) In case you inherit a locker, the belongings of the locker will be transferred under your ownership. The bank will release the belongings to you against an indemnity. No tax is levied here.

d) If the asset is a fixed deposit, the new owner can wait for the FD to get mature or close the FD account prematurely. The bank, in this case, will add deceased against the account holder’s name.

e) In case of inherited shares, the dematerialized forms are transferred automatically to the joint account holder, nominee or the legal heir depending upon the method of inheritance. You are then only liable to pay the income tax as per your returns.

f) The life insurance policy matures after the death of the insured. In this case, the nominee is required to apply with certain documents to get the claim.

g) In case of inherited vehicle, the new owner must transfer the vehicle under his/her name by filing an application with the state RTO.

Taxation Of Property Inherited Under A Will - The legal heir/representative of the deceased is/are required to file income tax returns for the period, from beginning of the year till the date of death, and include the income from the property in the returns filed, as legal representatives of the deceased. From the date of death and till the distribution of the assets, the executors of the will are responsible for filing the income tax returns. The income for this period shall be included in the return to be filed by the executors, in the status of ‘Estate of late (the deceased)’.

If the distribution of the assets happens in the same year as the death of the person, then, the person who gets the property from the execution of the will, has to include the income from the property in his/her personal income tax return from the date of acquiring it, till the end of the year. This may even be for a single day.

So, the number of persons who will have to pay tax, with respect to property acquired under a will, depends on the time taken by the executors to actually distribute the property.

Taxation Of Property Under Intestate Inheritance - In case the deceased has not prepared a will, or if the property in question has not been dealt with under the will, the property passes on to the legal heirs, immediately on the death of the person.

So, the heir/s who are entitled to the inheritance, become the owner/s of the property, on the day of death of the person, without there being any need for anything to be done by anyone. The income from property, from April 1 of the year, till the day of death, will be taxed in the hands of the legal representative of the deceased. For the rest of the period, it will be taxable in the hands of the person who has inherited the property.

In case of a let-out property, if the same is inherited by more than one heirs, the heirs shall inherit the property as joint owners. Each one of them shall be treated as owner of the part inherited and shall be taxed individually, for his share in the property, rather than as joint owners of the property and being taxed as ‘association of persons’ with respect to such property.

Specific Trust and Taxation - A Specific Trust is a trust where the beneficiaries are all known and their shares in the income and assets of the trust are defined by the settlor in the trust deed. Taxation of income of a specific trust is governed by section 161 of the Income-tax Act, 1961, (“the Act”).

For tax purposes, a trustee or the trustees is a “representative assessee”. Trustee of a specific trust is taxed “in the like manner and to the same extent” as the beneficiaries. 

In other words, theoretically, there can be as many assessments on the trustees as the number of beneficiaries.

However, there is only one assessment, but the income is computed as if the shares of the beneficiaries are taxed. Section 166 provides an option to the assessing officer to either tax the trustee or the beneficiaries separately on their shares of income from a specific trust.

In practice, we often find it simpler that the beneficiaries of specific trusts offer their respective share of income from a specific trust in their respective returns of income and get assessed.

Discretionary trust and Taxation - If either the beneficiaries are not identified or their shares are not defined by the settlor, the trust would be a discretionary trust. The distribution of assets and income is left to the discretion of the trustee. A beneficiary of a discretionary trust does not have any identified interest in the income. He only has a hope of receiving something if the trustee so decides. Taxation of income on discretionary trusts are contained in section 164 of the Act.

Trustees of a discretionary trust are taxed at the trust level in view of the provisions of section 164. This section provides that the income of a discretionary trust is taxable at maximum marginal rate. Only in cases where all the beneficiaries are persons having income below taxable limits, then the trust may be taxed at the slab rates applicable to an AOP.

Trust created through a will, enjoys this exception provided it is the only trust so created under the will. If a discretionary trust has business income, then such trust (barring a testamentary trust) is taxed at maximum marginal rates.

In cases where the income of a discretionary trust is distributed by the trustees to the beneficiaries during the year in which is earned.

Summary Of Cases

Madhya Pradesh High Court - It was held in the case of CIT vs. G. B. J. Seth and Anr (1982) 133 ITR 192 (MP), that though the assessment is on the executor or executors, for all practical purposes it is the assessment of the deceased. The Court has held that the status of AOP is for statistical purposes and that notwithstanding the status of the assesse being an AOP, the executors were entitled to claim set-off on account of the balance of brought forward losses incurred by the deceased prior to his death.

Mumbai ITAT - Purvez A. Poonawalla [ITA No. 6476/Mum/2009 for AY 2006-07]. It was held that sum received by the taxpayer from the legal heir of a deceased in consideration of the taxpayer giving up his right to contest the Will of the deceased is not chargeable to tax under the then prevailing section 56(2)(vii), which corresponds to present section 56(2)(x) in principle.

Supreme Court - CIT vs. Kamalini Khatau (1994) (209 ITR 101) (SC), the beneficiaries can be taxed directly on such income instead of the trustees being taxed. Status in which a trust is generally assessable is as an “individual” and not as an AOP. It is only in cases where the beneficiaries have come together voluntarily to form a trust, then, they may be assessed as an AOP8. Such would never be the case where a settlor settles a trust for the beneficiaries as part of his succession planning.

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BN - 20122019