How the Duke of Westminster dodged IHT

When the Duke of Westminster died recently, he left behind a vast estate – much of it exempt from inheritance tax. How so? Simon Wilson explains.

How much does the tax raise?

According to the latest figures from HMRC, inheritance tax (IHT) raised £4.7bn in the last financial year (2015-2016). That's more than ever before, due in large part to the long-run rise in house prices since the mid-1990s, and the fact that the threshold for starting to pay the tax has been held at £325,000 since 2009, dragging in more estates as house prices rise.

Over the past seven years, IHT receipts have jumped 91% – and there's been a 17% lift over the past year alone. Despite this rise, the tax still only accounts for a tiny fraction (0.87%) of HMRC's overall tax take, which was £534bn last year.

The taxman should get a boost from the duke's £9bn estate then?

Alas, no. When the sixth Duke of Westminster died recently, the taxman would indeed have been looking forward to the best part of £4bn in death duties if his reported £9.35bn fortune had been in the form of personal assets. But, as has been widely reported, the family's assets are in fact owned by a series of trusts, which come under the umbrella of the Grosvenor estates.

Some inheritance tax will be due on assets held personally by the duke, no doubt. But the bulk of the Westminster billions will be liable only to a periodic charge which is paid every ten years, and amounts to no more than about 6%. As the late Duke of Westminster once said of his fortune, " I would rather not have been born wealthy, but I never think of giving it up. I can't sell. It doesn't belong to me."

Why couldn't he sell?

As one of the trustees (the "legal owners") the duke could sell and buy assets within the trust, but did not have absolute rights over them. The "beneficial owners" of a discretionary trust's assets (who may also be trustees) can receive income from the assets, but this income is paid to them only at the "discretion" of the trustees. The upshot is that the assets are legally owned by the family as trustees, not individually, which means they not are subject to tax when a family member dies.

Has the family always been good at tax planning?

Apparently not. According to The British Tax System, a 1980s textbook co-authored by Mervyn King, "the largest sum ever paid in death duties, by a considerable margin, was the £11m [more than £200m in today's terms] paid on an estate estimated at between £40m and £60m on the death of the third Duke of Westminster" in 1963. It seems the Grosvenor family learned rapidly from the blow, however.

When the fourth duke (a cousin of the third) died in 1967, his estate pulled off something of a blinder. First of all, the declared estate was now just £4m. And second, they convinced the taxman that it should be exempt from estate duties.

How did they do that?

The taxman gave up his slice on the grounds that Colonel Gerald Hugh Grosvenor had died of wounds incurred on active service during World War II – despite the fact that he had survived a further 22 years and the cause of death was cancer. Meanwhile, the next duke, the fifth, also had notably savvy estate planning in place. When Robert George Grosvenor (the father of the duke who has just died) passed away in 1979, press coverage reported that the family fortune was now some £650m, yet the duke's declared personal estate, according to the Mervyn King book, was expected to be less than £5m.

Why is such tax avoidance legal?

Trusts and similar structures have been part of the legal framework in jurisdictions around the world for centuries – and that's because they have useful purposes unrelated to tax planning. The role of a discretionary trust is to protect family assets across the generations – most obviously by working as a kind of insurance policy against improvident behaviour by young or particularly reckless beneficiaries.

Trusts protect such beneficiaries from themselves, and also from creditors (or vengeful ex-spouses, for example). They offer flexibility and further protection if circumstances change, and can keep family assets outside of any divorce settlement.

Can anyone do this?

In theory, anybody could set up a discretionary trust to try and avoid IHT, but the prohibitive costs involved mean it would only be worth the hassle for the very rich. Moreover, ten years ago the law changed to make such structures less attractive, with a 20% levy on the value of assets going in (as well as the periodic ten-yearly charge of between 2% and 6%). Policymakers are of course free to change the tax law to further discourage the avoidance of IHT using trust structures.

Here at MoneyWeek we have long argued that inheritance tax should be fundamentally reformed so that the tax is not levied on a deceased person's estate, but on the income gifted to the beneficiaries. Such a system would be more progressive, less easy to avoid, and kinder to aged parents, who can stop worrying about whether and when to give away assets under the seven-year rule.

How the duke made his money

It is understandable that people get irate about vastly rich plutocrats using fancy structures to avoid taxes, says Tim Worstall in Forbes. So it's a little reassuring that the Grosvenor estate is very much the outlier as the great survivor among the British aristocratic estates. That's because, very unusually, the Westminster fortunes come not from agricultural land but from urban development.

In the second half of the 19th century, the steamship and railway began to destroy the role of farming land as the primary store of wealth by opening up new lands for European consumption (the prairies of America and Ukraine, primarily). Slowly, that killed off the great aristocratic fortunes – but not in Mayfair and Belgravia.