Taxation Aspects of Income of Deceased Person

Death and taxes are inevitable. Certainly, there is no exemption from tax on death of a person. Tax planning is required even in cases of succession. This undoubtedly expands the arena of tax professionals and creates new horizons.

Assessment of Income and derivation of tax liability in case of death of an individual has constantly been a subject of discussion. Drafting of wills and testamentary documents has been amajor avenuefor practicing professionals. However, there has been a long drawn disputes and debates regarding the incidence of taxation of income and tax liability of a deceased person. Under the Income Tax Act, 1961, the relevant sections are 159, 161, 162 and 167.

1. Who is a Legal Representative ?

Section 159 of the Income Tax Act, 1961, ‘Legal Representatives’ is the primary section that encompasses the liability of a legal representative of a deceased person. The provisions of the said section enables an assessment being made and tax recovered in respect of income of a natural assessee who was alive during a previous year but died either before the assessment proceedings were initiated or were completed. It enumerates the rights and liabilities of a legal representative. However, the liability of such representative is limited only to the extent to which the estate left by the deceased is capable of meeting the tax liability subject to the contingencies mentioned in sub-sections (4) and (5) of Section 159.

Now, it is important to understand the scope of the term ‘Legal Representative’ in the legal world. As per Section 2(29) of the Income Tax Act, 1961, “legal representative has the meaning assigned to it in clause (11) of section 2 of the Code of Civil Procedure, 1908.”Section 2(11) of Code of Civil Procedure states that “legal representative means a person who in law represents the estate of a deceased person, and includes any person who intermeddles with the estate of the deceased and where a party sues or is sued in a representative character the person on whom the estate devolves on the death of the party so suing or sued.”

There is another term that is often used as a substitute for legal representative: Legatee. Now, similarly, Legatees are the persons or entities that are designated within a decedent’s will to receive any gift (a “legacy”) from the estate. In other words, the legatees are the beneficiaries under the Will.

The question that now arises is whether the terms ‘legal heir’ and ‘legal representative’ are one and the same?

In this context, the following judicial pronouncements are briefly mentioned hereinafter:

– Judgment of Supreme Court in Custodian of Branches of BANCO National Ultramarino v. Nalini Bai NaiqueAIR 1989 SC 1589:‘A ‘legal representative’ as defined in Civil  Procedure Code means a person who in law represents the estate ofa deceased person, and includes any person who intermeddles with the estate of the deceased and where a party sues or issued  in  representative character the person  on  whom theestate devolves on the death of the party so suing or sued.The definition is inclusive in character and its scope iswide, it is not confined to legal heirs only instead itstipulates a person who may or may not be heir, competent toinherit the property of the deceased but he should representthe estate of the deceased person. It includes heirs as wellas persons who represent the estate even without rifle either as executors or administrators in possession of theestate of the deceased. All such persons would be covered bythe  expression’legal representative’.’

– Rajasthan High Court in the case of SmtKamlawati Gupta vs Kanwari Lal &Ors on 21 July, 2011 held that: ‘The term is inclusive of not only the heirs but also intermeddlers of the estate of the deceased as well as a person, who in law represents the estate of the deceased. It is not necessarily confined to heirs alone. The executor, administrators, assigns or persons acquiring interest by devolution under Order 22 Rule 10 or legatee under a will, are legal representatives. Under the personal law of Hindu Succession Act also, not only that class one heirs under Section 8 read with Schedule of the Act but also the executor of the will of the deceased testator are legal representatives within the meaning of Section 2(11) of the CPC.’

Based on the above definitions and the judicial pronouncements, it becomes clear that any person who gets the legacy (being a legal heir or not) is termed as Legal Representative. A Legal Representative may or may not be a legal heir of the deceased.

2. TESTATE V/s INTESTATE:

Death by testate refers to a situation where the deceased has left a will. Intestate indicates the absence of a will by the deceased. In case of testate, there is usually an executor mentioned in the will. However, there are instances wherein the will does not state the name of the executor. Letters of administration are filed by beneficiaries in case no executor is mentioned in the will, or, if the deceased has not made a will. The Court thereby, appoints an executor till the distribution of the estate of the deceased is made by way of probate.

3. ROLE OF EXECUTOR:

Section 168 of Income Tax Act, 1961 provides that the income accruing to the estate of a deceased shall be chargeable to tax in the hands of the executor. It further clarifies that, separate assessments shall be made 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. In case of partial distribution, the income distributed shall be excluded from the estate and shall be made taxable in the hands of the legatee.

Section 168 (3) makes it clear that the executor will continue to be assessed until the estate is distributed among the beneficiaries equally according to their several interests. [Navneet Lal Sakarlal vs. CIT (1992) 193 ITR 16 (SC)]

Executor shall be assessed in respect of the income of the estate under a PAN, different from his own. The executor is assessable in thestatus of “individual”. If, however, there are more executors than one, then, the assessment will be as if the executors were an AOP. However, the Madhya Pradesh High Court has held, in the case of CIT vs. G. B. J. Seth and Anr(1982) 133 ITR 192 (MP), that though the assessment ison the executor or executors, for all practical purposes, itis the assessment of the deceased. The Court had heldthat the status of AOP is for statistical purposes and that not withstanding the status of the assessee being an AOP,the executors were entitled to claim set-off of the brought forward losses incurred by the deceased prior to his death.

4. PERSONAL LIABILITY OF LEGAL REPRESENTATIVE:

Section 159(4) of the Income Tax Act, 1961 states that where legal representative creates a charge on or disposes of or parts with any asset of the estate of the deceased, while the liability for tax on income of the deceased remains undischarged, the legal representative shall be personally liable for any tax payable by him in his capacity as legal representative. However, such liability is limited to the value of assets charged, sold or parted with. Note: in this case personal liability of legal representative shall be limited to only tax payable and not for interest or penalty charges.

Further, Section 167 of Indian Succession Act, 1925 states that where property specifically bequeathed is subject at the death of the testator to any pledge, lien or incumbrance created by the testator himself then the legal representative, if he accepts the bequest, shall accept it subject to such pledge or incumbrance, and shall be liable to make good the amount of such pledge or incumbrance.

However, it shall not infer that the will shall contain any provisions for liability of the legal representative to pay the debts of the deceased. The liability of any legal representative shall be held effective only on the acceptance of the asset inherited by him through will and shall be limited to the value of such asset.

5. ASSESSMENT PROCEEDINGS:

In case a person dies during the pendency of his assessment proceedings, then the proceedings can be continued against legal representatives. Further, any proceedings that could have been initiated in case the person was alive, the same can be initiated against the legal representative/s.

‘In view of the provisions of section 159(2)(b) of the Act, it is permissible for the Assessing Officer to issue a fresh notice under section 148 of the Act against the legal representative, provided that the same is not barred by limitation; he, however, cannot continue the proceedings on the basis of an invalid notice issued under section 148 of the Act to the dead assessee.’ [Bipinbhai Bachubhai Kataria Vs ITO (Gujarat High Court) Special Civil Application No. 7850 of 2019]

6. Capital Gain Implications:

As per Section 47 of the Income Tax Act, 1961, the transfer of capital asset under will shall not be regarded as ‘transfer’ and hence, no capital gains arise.

Then the question that arises is what is the effect of transfer of capital asset intestate (death without will)? It is to be understood that transfer of assets on death is not actually transfer but transmission indeed. There is no consideration for the same. Hence, no capital gains shall arise in case of transfer by testate or intestate.

For the recipient, the assets received are capital receipts and not income. Section 56(2)(x), however, charges tax on receipt of assets without payment of adequate consideration. Proviso thereto exempts receipt by way of will or inheritance and therefore, such receipts are exempt in the hands of the legatee. The cost of acquisition shall be the cost to the previous owner and the period of holding shall include the holding period of the previous owner.

7. Carry Forward and Set Off of Losses:

Section 78(2) of the Income Tax Act, 1961 explicitly states that the successor shall not carry forward the losses of the predecessor, except in case of succession by inheritance. Therefore, a legal heir shall be allowed to carry forward and set off of the losses of the deceased but the concern is whether the same shall apply to other legatees as well.

Concluding Remarks:

The key takeaway is to recognize the difference between the terms legal heir and legal representative, death by testate and intestate, extent of liability of a legal representative, two assessments of income in the hands of executor and legatee and so on.