Recently, leaked documents from a Panama law firm revealed the tax avoidance activities of some of the world’s most rich and powerful people. It has been an embarrassing time for many, and has raised the issue of loopholes in our legal system and the moral judgement of those who use offshore tax havens.
Few people are wealthy enough to be in a position to move assets to offshore tax havens, but financial advisers often talk about tax efficient financial planning for the general public. These are two very different types of financial planning activity and the two topics should not be confused.
The Panama leaked documents reveal the affairs of the very wealthy who chose complicated tax structures in order to get around laws on paying tax in the country where they live. In the UK there are however simple and legitimate ways to reduce a tax bill: the government and HMRC actively encourage us to use them, and it is not tax evasion or tax avoidance.
Reducing your tax bill legally can be as simple as using an annual ISA allowance or engaging in good Inheritance Tax planning. As April is the start of a new tax year, it is something worth reviewing and considering now.
Tax-efficient investments; It's not just ISAs that offer tax breaks
The government is keen for people to use their ISA allowance to save and/or invest, and provide general allowances in order to encourage people to use them. The amount you can save or invest into an ISA in 2016/17 is £15,240 and any gains made are not treated as taxable income. You can transfer the money held in an ISA into a different ISA account, or between investments or cash, whenever you choose.
For those who are comfortable in taking investment risk, they could reduce their tax bill by putting their money in an Enterprise Investment Scheme (EIS) or Venture Capital Trust (VCT). Both of these investments are designed to encourage private investment in smaller companies by offering tax incentives to the investor. They are far more complex investment vehicles than ISA’s and can involve a significant amount of investment risk in return for the tax breaks, so it would be important to ensure the benefits are not outweighed by the risks.
Tax plan with your spouse or civil partner
There are tax reliefs which are available to married couples and civil partners, such as the Married Couples Allowance for those born prior to 1935 or the Marriage Allowance for those born after this date. However, these only work when one person in the relationship earns less and pays the lower rate of income tax. In particular, to benefit from the Marriage Allowance as a couple, the lower earning partner needs to earn less than £11,000.
Ensuring that any income producing assets are held jointly will also mean that any gains are split between the couple 50/50 and the tax due on these will be at each individual’s highest marginal rate of tax. So, again, if one partner pays higher rate tax and one pays basic rate tax, more of the gains will be taxed at the lower amount.
Incoming generating assets you can hold with your spouse include shares, investment funds, bank and building society accounts and property. It is worth seeking legal advice before transferring assets.
Similarly, it can pay to hold assets which are likely to incur Capital Gains Tax (CGT) together. The most obvious example of this is with a second home or buy-to-let property, which can often incur a high CGT bill on sale due to an increase in value since it was purchased. Each person has an annual CGT allowance (£11,100 in 2016/17) and so by holding a property jointly, you can each use the annual CGT allowance, as opposed to just one allowance if held in only one partner’s name. A capital gain is added to income earned in that tax year, so careful planning is essential before the disposal of this type of asset.
Those who are unmarried should also seek professional advice as the gifting of assets, such as property or shares, could incur a capital gains (CGT) bill.
Planning for death; how to minimise the Inheritance Tax paid on your estate
Many people find themselves approaching the later part of their life and are financially secure. For those who have a total estate which exceeds the threshold of £325,000 (£650,000 for married couples), then inheritance tax charged at 40% will have to be paid to HMRC on any amount which exceeds the threshold.
There are exemptions which allow a person to reduce future inheritance tax bills and those who have significant savings would be wise to consider using them. Everyone has an annual gift exemption worth £3,000, which removes this money from an estate regardless of how long you live. In addition, grandparents can give £2,500 to each grandchild who marries; parents can give £5,000. Gifting allowances are for each person, so a married couple can gift twice the amount.
Wealthier taxpayers can also make regular gifts out of income, which will also be inheritance tax-free and can be paid monthly, annually or even termly, if, for example, it was to help pay school fees. Financial gifts which are regularly made and fall outside the general allowances should be carefully recorded. A letter from the benefactor to the beneficiary stating that the financial gift is being made from excess income is prudent. Provided that the benefactor can genuinely maintain their current standard of living, there is no limit on how much they can gift this way.
If any financial gift is made which falls outside of the allowances, then the seven-year rule applies. This means that if the benefactor survives the transfer by seven years it is disregarded for inheritance tax purposes.
It's possible to give up part of your salary in return for other non-taxable benefits, such as childcare vouchers, where the part of your gross salary you exchange for childcare vouchers is tax-free and exempt from National Insurance contributions (NI). Because of this, a basic rate taxpayer can make savings of up to £933 a year.
You can also salary sacrifice into your pension. The added benefit when you pay additional money into your pension is that you also receive tax relief on the contributions made. This means for every £100 you pay into a pension, an additional 20% is automatically added into your pension on your behalf. If you are a higher rate tax payer, paying 40% or 45% income tax, then you can claim the additional tax relief when you complete your Self-Assessment tax return.
Paying into a pension is a good way to reduce your taxable income if you are employed or self-employed. For those who earn just over £50,000 and have children, reducing your income by making a pension contribution can ensure you continue to be eligible to receive child benefit.
To find out more about tax efficient planning, or to review your current investments or pension holdings, please say hello, we’d love to help.