A money bag and a wooden house on the scales. The concept of real estate purchase. Sale of property. Payment of the mortgage. Redemption of taxes. Tax refund. Legacy / Inheritance tax concept
IT is speculated that before the tabling of Budget 2025 on Oct 18, the Finance Minister would consider new taxes to shore up the government’s coffers.
Amongst the much talked about new taxes are estate and inheritance taxes.
Since Malaysia’s Estate Duty Enactment 1941 was repealed on Nov 1, 1991, it keeps hitting the news from time to time in the run up to the budget.
Estate and inheritance taxes are broadly similar because both are generally triggered by death. Estate taxes are levied on the net value of property owned by a deceased person on the date of their demise.
In contrast, inheritance taxes are levied on the recipients of the property.
Malaysia has had an estate duty on property inherited from the deceased person in 1941. There were 28 tax brackets, with the scale rates ranging from 0% to 40% and the highest rate was imposed on estate value more than RM5mil.
There were six reforms undertaken since 1941. Starting from 1984, only three tax brackets with scale rates (0%, 0.5% and 10%) – no tax on estate value less than RM2mil while highest tax rate on estate value more than RM4mil.
On Nov 1, 1991, the Estate Duty Enactment 1941 was abolished, ending the inheritance tax after 50 years.
For the period 1941 to 1991, the amount of revenue collected was between RM24mil and RM40mil per year, with the ratio to total tax collection between 0.04% and 0.5%, indicating the low revenue relative to the administrative and compliance costs.The inheritance tax is a much-debated topic in the public discourse. There are merits and shortcomings.
The basic reasons for imposing an inheritance tax are to increase tax revenue, and to reduce wealth inequalities (income disparity) between the rich and poor. The rich persons would pass on all of the accumulated wealth to their heirs and the heirs would continue to build on it without much effort.
Additionally, the assets inherited consist of “unrealised capital gains” that have never been taxed, which can be taxed under the inheritance tax.
In contrast, poor persons wouldn’t have assets to pass onto their kith and kin. The heirs will have to work hard to break out of the cycle of poverty.
The widening income divide between rich and poor is validated by the Organisation for Economic Co-operation and Development or OECD (2021), Inheritance Taxation in OECD countries, which showed that the wealthiest households (or the top 20%) in OECD countries have received close to 50 times higher inheritances and gifts as compared to the poorest households (or the bottom 20%).
A dysfunctional tax?
With the generous exemptions, carve-outs and generous lifetime donations as well as loopholes that can be exploited to avoid the tax, inheritance and estate tax is a minor source of revenue in most countries and often makes inequality worse.
In the United States, only 0.2% of estates pay inheritance tax.
These taxes have high compliance and enforcement costs.
Assessing the value of assets is difficult, and hence, incurring high administrative costs to recoup that drop in the tax ocean simply is not worthwhile, particularly if those assets are not that valuable.
The OECD study indicated that 24 OECD countries’ inheritance or estate tax made up only 0.5% of overall tax revenue on average across 24 countries in the OECD group of mostly developed countries that have such levies.
Many countries have eliminated their inheritance or estate taxes.
In Asean, only Vietnam and Thailand impose inheritance tax.
Singapore, China, Hong Kong and Australia do not have inheritance tax.
In 2008, Singapore had abolished the inheritance tax, paving the way to entice the wealthy individuals in the region to move their assets to Singapore, contributing to a vibrant growth of the wealth management industry, including family offices.
Many European countries have conducted changes and reforms with respect to inheritance taxation.
Austria abolished inheritance taxation in 2008.
The revenue benefits of the tax are being outweighed by the administrative, political, and economic costs of levying a tax on a narrow base, and repeal becomes a more and more viable option.
It is not a good idea to impose inheritance and estate taxes as they deter capital formation, stifle entrepreneurship and discourage expansion as well as growth of the enterprise. Ultimately, they act as a deterrent to wealth accumulation, resulting in lower investment, lower employment and dampening effects on the economy.
Some have argued that it is fundamentally unfair because tax is levied twice on capital income, that is once when people earn their money and again when they die.
The wealth accumulated over generations is the property of the family and the government is not entitled to intervene.
As the inheritance falls almost exclusively on the domestic capital stock and assets, Malaysia still needs sustaining flow of long-term domestic and foreign funds to accelerate its transition into a high-income nation.
We need to keep incentivising and motivating entrepreneurial spirit to invest and accumulate wealth, providing a pool of capital to help enlarge the economic pie.
With the imposition of estate and inheritance taxes, entrepreneurs may have less incentive to expand their business operations as it will ultimately increase estate tax liability.
Taxing inheritance may trigger migratory responses.
We must not underestimate the threat of capital flight as wealthy individuals and families move their assets and funds to more inheritance-friendly countries and therefore exiting the tax base.
It impacts not only the tax revenue but also reduces the supply of capital and funds, which can be mobilised for domestic investment.
Worse still, some of our high-net-worth individuals, wealthy residents, highly paid professionals and successful entrepreneurs may relocate to abroad so that they will not be taxed.
Additionally, the inheritance tax may reduce the number of Malaysians and foreigners bringing their assets into Malaysia.
Wealth management
Often family offices are established as a means to manage the interests of an individual or their broader family, focusing on wealth succession management, and to the next generation.
The establishment of family offices would be impeded on concerns over how the beneficiaries may be taxed.
In practice, the wealthy people can find ways to dodge the inheritance tax. This includes forming a family trust, which insulates their assets because there is no transfer in ownership of assets, only a change in the trust shareholding.
The inheritance tax can be avoided through tax planning by gifting properties to the next generation during their lifetime.
In terms of practicability, the inheritance tax would result in a huge financial burden on the deceased’s heirs, forcing some of them to sell the inherited assets in order to pay the tax.
Bear in mind that the long-life property would have appreciated in value many multiple times over decades, and hence, have to pay higher heritance tax on the property.
Expensive and cumbersome
In addition, complying with the tax can be expensive and cumbersome as entrepreneurs need to engage in significant estate planning when passing their assets onto their heirs.
The valuation of some inherited assets such as family antiques, paintings and jewellery can be difficult and subjective, leading to dispute.
In conclusion, the correlation between inheritance, estate taxes and income equality is not strong and its low revenue collection indicates its ineffectiveness.
From a tax-revenue raising point of view, the government can consider reintroducing a broad-based consumption tax (goods and services tax), which is a fairer, more transparent and efficient as well as easing the administration tax regime.
The inheritance tax is losing ground around the world, because it can stifle entrepreneurship, discourage entrepreneurship and investment, cause the exodus of capital and assets by the ultra-rich people and professionals to other inheritance- tax friendly countries.
Lee Heng Guie is Socio-Economic Research Centre executive director. The views expressed here are the writer’s own.
