HMRC has recently clamped down on tax avoidance, which is defined as “bending the rules of the tax system to gain a tax advantage that Parliament never intended”. This often involves contrived, artificial transactions that serve little or no purpose other than to produce a tax advantage.
However, it is still possible to save thousands of pounds per year legitimately and legally, due to the way in which the tax system is set up. Tax planning is an important part of financial planning and remains completely legitimate on the basis that it is both within the letter and the spirit of the law.
- Tax-free allowances: Many types of tax allowances are available, enabling an individual to have over £28,000 tax free. These include, but are not limited to: savings income, marriage and capital gains allowances. A couple of new allowances have also been introduced to help micro-entrepreneurs, who earn money through selling services or renting out their homes via the internet.
- ISAs: The current tax-free ISA allowance of £15,240 is due to rise to £20,000 from 6 April 2017. ISA savings can be divided between different types of ISA each tax year. The Innovative Finance ISA (IFISA) was introduced in April 2016 to shelter peer-to-peer (P2P) lending from tax, giving holders the opportunity of returns which are potentially significantly higher than from cash deposits, although capital is at risk and not covered by the FSCS. The government is introducing a Lifetime ISA (LISA) for individuals under age 40, to fund a first home or retirement subject to £4,000 pa. It will include a government contribution of 25% on savings. Junior ISAs (JISA) are available for children, subject to a limit of £4,080 pa.
- Pensions: Tax relief is available at an individual’s marginal rate of tax on annual earnings, subject to an annual allowance of £40,000 and some restrictions for high earners. It is also possible to start to save a pension on behalf of children, who benefit from 20% tax relief on contributions. At retirement, generally 25% of the pension can be drawn tax-free and up to £1m can be potentially sheltered from Inheritance Tax (IHT).
- Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCT): Tax relief is given to investors who purchase shares in qualifying smaller, higher risk companies, allowing them to raise finance. Income Tax relief is given when you buy newly issued VCTs or EISs, currently at the rate of 30% subject to annual limits and an individual’s tax liability. However, EIS must be held for at least 3 years and VCTs for minimum 5 years to retain the Income Tax benefits. EIS also allows an individual to defer capital gains; and shelter Inheritance Tax (IHT) after 2 years; any loss on the EIS can potentially be offset against either Income Tax or CGT. VCTs can pay tax-free dividends and any gains are exempt from CGT.
- Renting a room: This only applies to those that are renting a room of their own home, but an individual can earn up to £7,500 tax free.
- Charitable giving: Those in the higher-rate tax threshold can reduce the amount of tax they pay through using tax relief on charitable giving. Gift Aid has become popular in the last few years, with charities and community amateur sports clubs being able to claim 25p for every £1 given from the government. Taxpayers earning over £43,000 can use their tax return to claim higher rate tax relief from charitable giving.
- Salary Sacrifice: Taking advantage of schemes that employers offer, such as childcare and pensions can potentially save an employee tax.
- Inheritance Tax (IHT): Each year an individual can gift £3,000 exempt of IHT. From April 2017, the government is introducing a new Residence Nil Rate Band (RNRB), which by 2020 will potentially allow a married couple to pass on a home of up to £1m to children or grandchildren free of IHT, subject to a restriction for any estates over £2m. Whilst an individual normally has to survive for 7 years for a gift to be IHT-free, planning using regular gifts of surplus income can be immediately exempt from IHT. In addition, assets which qualify for Business Property Relief or Agricultural Property Relief can become IHT-free after 2 years. Trusts are often used for IHT planning, as well as giving control of assets for the potential benefit of family members.
- Family Limited Partnerships: These partnerships are becoming more common and share similarities with a trust, but benefit from a lower tax rate.
- Capital Gains Tax (CGT) transfers: transfers of assets between spouses are free of CGT. This rule can enable effective planning if a spouse is terminally ill. Gifting them shares or property, which can then be transferred back in their will free of inheritance tax, can eliminate CGT, as CGT does not apply when the owner of an asset dies. Individuals have a CGT exemption of £11,100 pa currently.
- Classic cars: Classic cars tend to increase in value, as their demand increases. This can be beneficial to those wishing to profit from their tax-preferred status. Whilst trading cars is taxable, a one-off sale would generally avoid CGT.
- Property: It is well known that an individual’s home is exempt from CGT on sale. If an individual owns more than one property, it is possible to elect which property is your primary residence within 2 years. The tax rules allow an individual to claim relief from CGT for the last 18 months on a property which has been a home irrespective of whether an individual is resident on sale. However, such house ‘flipping’ has come increasingly under the spotlight following the 2013 General Anti-Abuse Rule (GAAR) and it is important to act within both the letter and spirit of the law.
- Incorporation: Companies have become increasingly popular for tax planning as Corporation tax rates have fallen from 28% in 2010 to 20% today and due to reduce further to 17% by 2020. Companies can help save National Insurance and tax through flexible planning, such as drawing profits as dividends rather than salary.
Please note, this article is for information only and does not constitute investment or tax advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise; pension rules and tax legislation are subject to change; we do not give tax advice. If you would like investment or pension advice on your individual circumstances, please do not hesitate to get in touch on 01392 875500 or info@SeabrookClark.co.uk