David Cameron and Inheritance Tax

To avoid tax you have to do a thing which cuts your tax bill.

Fail to do that thing and your tax bill is higher. But do it and you’ve avoided tax compared with an alternative world – economists call it a counterfactual but you and I would call it an overdraft – in which your tax bill is higher.

If this all seems a bit, well, metaphysical, it shouldn’t.

When Ian Cameron died, David Cameron received £300,000 in his will. That’s just below the maximum amount you could, at the time, pass on free of inheritance tax. Most or all of the rest went to David’s mother and, because she was Ian’s wife, it went tax free. She promptly gifted the Prime Minister a further £200,000 by way of what Downing Street is describing as an equalisation payment (a payment to ‘equalise’ the money that the children received from their father).

That’s the real world. If she survives the gift by seven years that will save £70,000 compared with an alternative world in which the money went straight from Ian to David.

The mere fact of making gifts whilst you’re alive can – if you’re wealthy at least, because only a very few people are rich enough to pay inheritance tax – avoid inheritance tax. But I wouldn’t describe it, without more, as meaningful tax avoidance. It’s a rule that the statutory draftsman has created and you’re using it as she intended.

But what takes this little two-step into the realm of meaningful tax avoidance is that it would have been known before Ian’s death what sum David needed to get in Ian’s will to ensure he received the same amount from his father as his siblings.

The natural thing to do – and so to me the appropriate ‘counterfactual’ to what actually happened – would have been for Ian to make the gift in his will. But instead Ian gave him a sum of such a size that there would be no inheritance tax to pay. And then David’s mother gave him a little bit more in such a way that, if she outlived the gift by seven years, there would have been no inheritance tax to pay.

Compare that counterfactual to what actually happened and there’s a £70,000 inheritance tax saving.

I think this is, in a meaningful sense, tax avoidance.

57 thoughts on “David Cameron and Inheritance Tax

  1. Can I just ask how does anyone know that Mrs C did not have the £200k she gifted to DC in her own name and that the money actually wasn’t ‘Ian’s’ and even if it was from IC’s estate where in law does it say this is in anyway illegal?

  2. No one’s suggesting it’s illegal. I’ve pointed to the fact that the payment was designed to equalise what the siblings got from their father as being decisive (to me at least) of the choice of counterfactual being a gift from father to David of £500k giving rise to an extra IHT bill.

  3. So if Mrs C had said ‘I’ve done this to equalise the what the siblings got BUT from my own money that I had prior to IC’s death’ then is that not equally as decisive?

    In fact, no one knows where the money came from initially, but it was in Mrs C’s name at the time of the gift?

    What I think you’re saying is that by doing this they have avoided paying IHT than would have been paid if they had done something else

    Both the inheritance and the gift are within the ‘rules’ and I just don’t see how you can suggest there is anything wrong here.

  4. Picking up some earlier comments, it is far from clear why the spouse exemption should be unlimited (it isn’t for non-domiciled donors) and it is not clear what its purpose is. It is not just a deferral of IHT because the inherited assets do not necessarily come back into tax….as the Cameron case illustrates. Indeed the spouse exemption offers (courtesy of the donee’s nil rate band and/or PETs by the donee) a paving exemption for tax planning which substantially reduces the overall IHT bill on the death of the donor. Add in the tax-free uplift on the donor’s death for CGT purposes and the attractions of this kind of planning become even greater. And it goes without saying that these benefits accrue mainly to the wealthy because the less wealthy donee is unlikely to be able to make large lifetime gifts.

    If the spouse exemption were restricted, it should still be possible to deal with the case of someone on a lowish income living in a valuable marital home. This could be done by deferring the payment of tax until that home was sold or its value otherwise realised or (perhaps) until the donee made large lifetime gifts.

  5. This is all ancient history, but there has been a general and unlimited spouse exemption ever since capital transfer tax was introduced (by a Labour government) in 1975 (see schedule 6 Finance Act 1975). Unless of course your spouse is not UK domiciled.

    As I understand it, under estate duty, the position was reversed: gifts to a spouse were taxed, but then that amount was exempted from a second charge on the death of the spouse (Finance Act 1894!). In the Commons debates, Mrs Thatcher complained that the change could increase the tax payable on the second death. But it is clear from the debates that the intention was to ensure the inheriting spouse could enjoy the whole of the estate without tax.

    To quote two Labour ministers:
    * John Gilbert: “When a widow—the same consideration applies to a widower—is suffering great distress, she should not simultaneously have to sell up her home and move immediately into far more modest circumstances than her reduced income would require.” http://hansard.millbanksystems.com/commons/1975/jan/15/income-tax-alteration-of-additional
    * Denis Healey: “The lower limits we are introducing in the capital transfer tax and the exemption for spouses make this new tax much fairer than the older one and infinitely more efficient.” http://hansard.millbanksystems.com/commons/1975/jan/21/capital-transfer-tax

    Whether this should still be the case is another matter.

    Slightly less ancient history, but we have had PETs since capital transfer tax became inheritance tax in 1986.

    If we have a free hand, what we should probably do with inheritance tax is reduce the rate – 40% is penal – and broaden the base. But it remains very unpopular. Another alternative might be to roll it into capital gains tax, so a transfer on death would be chargeable. A substantial question then is whether you want to retain APR and BPR, or accept that an unexpected death could result in the break up of a successful family farm or business.

  6. When an unlimited spouse exemption was first created, there was no scope to make PETs under capital transfer tax. So in its current form, the spouse exemption has changed significantly from what was first envisaged. Effectively PETs recreate much of the structure of estate duty but with a full spouse exemption. The exemption does not just apply on death and in any case, the distraught widow scenario cited is a red herring.

    Inheritance tax is unpopular but in my opinion, this has much to do with the way in which the tax burden falls. The very rich largely avoid it for the reasons discussed while the lower middle classes do not/cannot. It has become a major engine of wealth inequality. Change that regressive feature and I suspect much of the unpopularity would fade. Perhaps the new main residence nil rate band is a step in this direction because it cannot apply to larger estates. The current structure of APR and BPR is itself problematic. They are overly generous and have themselves been a target for much inheritance tax planning.

    Charging capital gains on death strikes me as only a partial answer. At the very least it would require progressive rates of capital gains tax, an equivalent of the nil rate band and the removal/radical restriction of main residence relief. Its territorial scope is also very different to that of IHT. In any case, CGT is not well-targeted to tackle the wealth inequality issue mentioned above…..not least because it only addresses capital gains.

  7. If your purpose is to address wealth inequality (rather than just to raise money) then you probably want an annual wealth tax rather than waiting a lifetime to charge 40% (or in many cases not charge 40%).

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