With the new tax year looming, now is an ideal time to review your position and decrease your tax liabilities.
Tax avoidance usually centres on taking advantage of legal loopholes, meaning that this behaviour is not technically illegal. However such practices are still seen as being unethical and unfair to honest taxpayers who pay their fair share without fail.
Tax avoidance has become so aggressive in recent years that it is increasingly being labelled “tax non-compliance” – a label closely associated with tax evasion.
This leads the offender open to retrospective action by HMRC, which can leave them financially worse off than if they had played by the rules. And let’s not forget the inconvenience of a lengthy, mentally draining tax investigation.
Conversely, strategic tax planning centres on making the best use of the allowances and schemes that are legally permitted. Many people, and their accountants, are then able to sleep well at night knowing that they have complied with the law and HMRC won’t be knocking on their door any time soon.
With this approach, there are many parameters to consider and sometimes it is not beneficial to use all of your allowances. There are many implications to consider, first.
Income tax planning
There are two key characteristics of income tax planning: the first is reducing your current tax liability in a particular tax year, the second is aiming to reduce your level of taxable income over the coming years.
ISA allowances should be used as much as possible; even if this is held in cash at distinctly underwhelming interest rates. Taking advantage of the allowance will safeguard your capital from income tax and capital gains tax for many years.
If you are married or in a registered civil partnership, you could consider transferring ownership of income-producing assets to allow you to benefit from two sets of personal allowances and basic rate bands. You will also be able to:
- Utilise lower tax rates where one partner either pays the higher rate (40%/32.5%) or additional higher rate (45%/37.5%) of tax.
- Preserve the personal allowance where one partner’s income exceeds £100,000.
- Preserve the age specific personal allowances for people over 65 by keeping income below £26,100 (or £27,000 for 2014/15).
Technically speaking an ISA isn’t a totally tax free investment, as the 10% dividend credit is non-reclaimable in tax wrappers, therefore basic rate tax is essentially paid even in situations where dividend income arises within an ISA or pension wrapper.
By holding interest-bearing assets within tax wrappers, savings interest can be received gross. Plus any dividend-producing assets held outside the wrapper will offset the dividend credit against income tax.
Investment bonds can be utilised to deliver a tax-deferred ‘income’ stream. Any taxable gains triggered by a bond encashment is decreased by the number of years that the bond has been active to apportion the gain between tax bands. However, the entire gain is added to the individual’s taxable income to calculate their entitlement to the personal allowance – which could lead to them indirectly incurring more income tax. In which case, it may be appropriate for the individual to stagger encashment payments across multiple tax years.
If the gain on the bond falls into higher rate tax bands, a personal contribution may allow some, or all, of the bond top-slice into a lower tax bracket. But this will not allow the individual to sidestep the personal allowance trap – that is unavoidable!
Surplus income, but not surplus capital
Changing income-producing assets to growth assets will just postpone taxation, since gains will ultimately be analysed through Capital Gains Tax (CGT), but it does give people more control over the timing and size of their tax bills. Plus, CGT tax rates are much lower in comparison to income tax.
Both surplus income and capital
Gifting capital to individuals and trusts can help you reduce future income tax, CGT and IHT liabilities.
Just remember that for this to be effective it has to be an outright gift, so ensure that the capital is surplus to requirements, both now and in the near future.
The benefits of income tax planning
In situations where measures have been taken to reduce an individual’s income tax liability, such as pension contributions or charitable gifts, the individual must remember to claim the tax relief from HMRC. It seems pretty obvious, but many taxpayers fail to claim their tax relief each year, which completely counteracts any benefit of tax planning.
If you’re due tax relief, contact HMRC to claim the refund. The longer you wait the longer it will take for you to receive this.
Alternatively, if the total taxable income is lower than the personal allowance, make sure you fill in Form R85 as this will allow you to receive your savings income gross, rather than waiting for a refund.
To speak to an expert call KinsellaTax NOW on 0800 471 4546.