Understanding Tax Avoidance

understanding tax avoidance

There is no question that some transactions which result in the lowering of a person’s tax bill are perfectly legitimate whilst others are not.  However separating out those transactions which should be banned is not always straightforward.

For example, when a person makes pension contributions they are at the same time reducing their tax bill as a result of a wealth of government legislation designed to encourage the “good behaviour” of saving towards a comfortable retirement.  This therefore can be seen to be a perfectly legitimate way to behave.

However consider the situation, which has been much reported in the press recently, of David Cameron following the death of his father.  His father left him £300,000 and left the remainder of his estate to his wife.  She then made a gift of £200,000 to David.  Provided she survives 7 years there will be no Inheritance tax to pay on this gift of £200,000.  However, had David been left £500,000 by his father instead of £300,000, there would have been an Inheritance Tax bill of £70,000.

Also consider the following example; Oxfam, like other charities, receives a government bonus for cash gifts made by the taxpayer.  Importantly, this government bonus does not apply to gifts of clothes as these are not cash.  However if the taxpayer appoints Oxfam as its agent to sell goods for him or her and then make a gift of the proceeds, then the gift becomes cash which will therefore be eligible for the government bonus.

These two examples show how difficult it can be to decide which tax avoidance behaviours should be banned.  One way of approaching such a decision would be to consider what real transaction has taken place and what tax charge this real transaction would have attracted.

Considering the Oxfam example, therefore, it can be argued that the real transaction was in fact a donation of clothing which is not eligible for the government bonus.  By this reasoning this would seem to be non-legitimate tax avoidance.

The example involving David Cameron however, is much less clear simply because we cannot know the intentions of the principle characters.  Whether this was a deliberate act on the part of David Cameron’s father to avoid Inheritance Tax or whether David Cameron’s mother made a separate decision to gift some money to David after her husband’s death is something we shall probably never know.  However, this knowledge is key to determining whether tax avoidance took place; whether the real transaction was in fact a gift of £500,000, which would have attracted an inheritance tax charge, or whether there were in fact two separate real transactions.

One thing, however, is clear; the area of Estate Planning is a complex one and we recommend that you seek the help of an Independent Financial Adviser before you act.

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