While everyone should pay their share of tax, there is no reason to pay more than you are expected (legitimate tax avoidance rather than illegal evasion).
“Tax evasion” may be defined as efforts to evade the payment of taxes by illegal means. Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax liability, and includes, in particular, dishonest tax reporting (such as not declaring taxable income, profits or gains; or overstating deductions). In the UK tax evasion is a crime and subjects the guilty party to fines or even imprisonment while tax avoidance on the other hand is legal and everyone has a right to do their utmost to legally pay the least tax they can.
Some ways of legitimately reducing tax are fairly straightforward and can be low risk, for instance if you are holding cash for a period of time you should probably consider putting it in an ISA of some description (although with the current ultra-low interest rates and the savings income allowance the current benefits of this are probably for the few rather than the many).
There are however various other relatively “simple” tax planning areas that individuals can consider and a few examples are:
Make the most of income tax allowance and tax bands
If you are married (or in a registered civil partnership) and your spouse pays less tax than you it may be tax efficient to move income yielding savings into their name to make full use of their personal allowances and basic rate tax bands. You can in addition, provided you meet various requirements, transfer £1,150 of an individual’s personal allowance to a husband, wife or civil partner – if they earn more than you – known as the “Marriage Allowance”. This reduces the recipient’s tax by up to £230 in the tax year (6th April to 5th April the next year). In simple terms to benefit as a couple the lower earner must have an income of £11,500 or less in the 2017/18 tax year. Interestingly if you qualify then there is the potential to backdate your claim to include any tax year since 5th April 2015 that you were eligible for Marriage Allowance. If you qualify then in essence this is free money, so worth checking?
Make pension contributions?
Investing in a pension for retirement is one of the most tax efficient ways to save. Pension contributions currently receive up to 45% tax relief. A £1,000 payment by an individual into a SIPP potentially benefits from £250 basic rate tax relief added automatically. Higher rate taxpayers can claim up to a further £250 in tax relief, while 45% rate taxpayers can claim back up to £312.50. You must however pay sufficient tax at the higher/additional rate to claim the full tax relief via your tax return. If you’re a UK resident, under age 75 and not drawing from your pension fund, the general rule is you can contribute as much as you earn to pensions per tax year, effectively capped at £40,000.
Pension for your spouse/civil partner?
Investing in pension for a non-earning spouse/civil partner is one of the most generous of government pension give-aways and a great way to maximise the higher personal allowance in retirement. Non-earners can make a £2,880 pension contribution and the government adds £720, even if the individual pays no tax. (More free money!)
At retirement from age 55, 25% of the value of the pension fund can normally be taken as tax-free cash, with the balance being taxable. However if further withdrawals fall within the individual’s personal allowance each year, these will also be tax-free.
Save Inheritance Tax (IHT) – the new main residence nil rate band
April 2017 saw a new, additional inheritance tax allowance – the main residence nil rate band, introduced. This initially adds an additional £100,000 IHT allowance onto the current nil rate band of £325,000 and potentially reduces the estate tax paid on a main residence. The main residence nil rate band rises to £175,000 by 2020 meaning a couple could pass £1 million to beneficiaries IHT free by then. However, this will only work if various requirements are met such as the property is valued at more than £350,000 and less than £2 million (after which the allowance tapers) and the individual’s direct descendants inherit the home, or a share of it with specific definitions provided in the legislation for who qualifies as a “direct descendant”.
The new main residence nil rate band is also available when a person downsizes or ceases to own a home on or after 8th July 2015 and assets of an equivalent value, up to £175,000 in 2020‐21, are passed on death to direct descendants. For example, an individual might choose to downsize from a home worth £200,000 to a home worth £100,000. They could still benefit from the maximum allowance of £175,000 in 2020‐21 if they leave the home and £75,000 of other assets to direct descendants. In this example they will only be liable to inheritance tax if the total estate exceeds £500,000. Again it is important that all of this is documented correctly and within the legislation.
Finally when considering IHT I am always reminded of the famous quote by Lord Jenkins of Hillhead, the former Labour Home Secretary and Chancellor of Oxford University, who said that, “Inheritance Tax is, broadly speaking, a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”. Overall in this respect the new RNRB is to be welcomed but, while it will hopefully reduce the IHT bills faced by many families, it also adds a new level of complexity to estate planning and many individuals and couples will undoubtedly need help and education in this area.
Legitimate tax planning is something that everybody should be doing and this short article only scratches the surface in terms of areas to consider. The fact is that as with many things in life having the assistance of a professional just makes it a little easier.
Andy Gadd – 27th July 2017