Australia's Future Tax System

Final Report: Detailed Analysis

Chapter A: Personal taxation

A3. Wealth transfer taxes

A3–3 Parameters for a possible tax on bequests

Recommendation 25:

While no recommendation is made on the possible introduction of a tax on bequests, the Government should promote further study and community discussion of the options.

A large number of design choices would need to be made if a bequest tax were adopted. This Report does not make recommendations on these issues — further work is needed before a fully articulated proposal could be considered. It is, however, possible to suggest parameters for the most important design features.

A tax on the whole estate or on individual inheritances?

A tax on bequests may be an estate tax, an inheritance tax or an accessions tax.

An estate tax applies to the whole of an individual's estate, regardless of how many recipients there are. It could be designed to favour bequests to spouses or to other categories of recipient: bequests to such recipients could be concessionally valued or could receive a flat percentage discount. It would be relatively easy to apply, as the whole of the estate would be taxed as one unit.

An inheritance tax applies separately to each inheritance received by an individual. If a progressive rate scale were adopted for either an estate or an inheritance tax, the adoption of an inheritance tax would provide more incentive for donors to split their estates between recipients to reduce the total tax payable on the estate. To collect the same revenue from the same base of bequeathed assets, the rates for an inheritance tax would need to be higher than the rates for an estate tax. An inheritance tax accords better with an income tax system, as it taxes the bequest in the hands of the recipient rather than in the estate of the donor. An inheritance tax may be more horizontally equitable than an estate tax, in the sense that two people who receive the same amount of inheritance will generally pay the same amount of tax, regardless of the size of the estate from which the inheritance comes.

An accession tax taxes all gifts and inheritances received by a particular person on a cumulative basis. It takes account of the fact that some recipients receive a number of substantial inheritances over the course of their lives, though at the cost of some complexity. In particular, it requires the tax authorities to maintain a record of gifts and inheritances received over the course of a person's lifetime. It could also involve adjusting past receipts for inflation. Among OECD countries, only Ireland has implemented an accessions tax.

While there are arguments on both sides, an estate tax may be the best model for Australia. It avoids the lifetime complexity of an accessions tax and is simpler to administer than an inheritance tax. It accords with a tax system structure under which income savings are subject to relatively uniform low rates of tax and it removes incentives for donors to split up their estates to minimise the tax payable.

The breadth of the base

A bequest tax would be simpler to administer and more economically efficient if it had a broad base, with no exemptions or concessions for particular asset types. Concessions for particular asset types would greatly complicate the design of the tax and would open up avenues for tax planning and avoidance. A comprehensive base would include all financial and non-financial assets, including owner-occupied housing, offset by outstanding liabilities. If a person's net assets were less than the threshold, no tax would be payable.

Setting sensible rates

A tax on bequests could have its own rate scale, which is the approach taken in most OECD countries, or some portion of the inheritance could be included in the recipient's income for income tax purposes. The Review recommends moving away from a comprehensive nominal income benchmark towards a system where capital income is taxed at relatively uniform rates lower than the rates applying to labour income. It would not, therefore, be consistent to include inheritances in the recipient's other personal income. Instead, a separate rate scale would be appropriate.

It would not be appropriate to specify a rate scale for an estate tax at this time: more analysis would be necessary before that could be done. Nevertheless, some parameters are clear. Given the very uneven distribution of wealth among Australian households, a tax that fell only on large estates would raise much of the revenue available. It would, therefore, be appropriate to set a substantial tax-free threshold, so that the large majority of estates would not be affected. The threshold should be indexed to wages to preserve its value in terms of community standards.

The tax could also be aligned with means testing for income support payments so that the holder of a high-value estate, assessed on a household basis, would not be eligible for means tested income support or family payments. Importantly, the tax base would include the value of owner-occupied housing.

Beyond the threshold, a fairly low flat rate would be desirable. A bequest tax should not be designed to prevent the transfer of wealth between generations, but as an efficient and equitable means of generating a relatively small proportion of total tax revenue. Too high a rate would run the risk of inducing large changes in donors' saving decisions and would encourage more aggressive tax avoidance.

Other design issues

Any option for taxing bequests and gifts would require consideration of:

  • the cash flow implications for estates held predominantly in the form of illiquid assets;
  • the treatment of bequests to charities, which are concessionally taxed in many countries;
  • how the tax would interact with capital gains tax;
  • how the tax would interact with the taxation of superannuation benefits on death;
  • the treatment of non-resident donors and property located outside Australia; and
  • the design of a gift tax to accompany the bequest tax. This would raise a number of difficult questions about what range of gifts from parents to children — which may take the form of Higher Education Loan Programme payments or contributions to student living expenses — would be included.