Tax Avoidance or Tax Evasion? The legal steps can you take to reduce the amount of tax paid?
The UK government is financed with an impressive array of taxes, with personal taxes making up a significant proportion of the total tax intake.
HMRC’s main drive is to close the ‘tax gap’ which is the difference between the amount of tax that should, in theory, be paid to HMRC, and what is actually paid.
It arises partly due to taxpayer error, but also due to legal interpretation, evasion, avoidance and criminal attacks on the tax system. As a result, HMRC is constantly focusing on reducing this deficit.
Clearly, taxes on income and assets are taken very seriously by HM Treasury as well as UK taxpayers themselves.
What is the difference between paying less tax and tax evasion?
Put simply, Tax mitigation is legal and legitimate whereas tax evasion is illegal.
Denis Healey, former UK Chancellor of the Exchequer, once said: “The difference between tax avoidance and tax evasion is the thickness of a prison wall”.
So Tax avoidance is not technically illegal; however, the ethics are open to question.
Approaches used by the Tax Man to curb tax evasion
Over the years, a range of anti-avoidance legislation and case law has built up. This is partly because of the need to close loopholes and partly as a result of the development of ever more complex and sophisticated avoidance schemes.
This has become a sort of ‘arms race’ between HMRC and mainly wealthy clients and their tax advisory firms.
These government has at its disposal, The General Anti Abuse Rules, The Disclosure of tax avoidance scheme regime (DOTAS) while anything else is swept up by the general anti avoidance case law that evokes the Ramsay principle.
The Ramsay principle says that tax must be charged where a scheme has no purpose other than to avoid tax. This will cover schemes that involve a transaction effected via a series of steps. Where they look at the effect of the whole series and not at the tax position of each individual step.
Through the operation of these schemes the tax authorities now have the power to see through the most innovative attempts to evade paying tax.
HMRC Successes in recouping unpaid tax
The effectiveness of these organisations has led to thousands of actions being taken, which is often highlighted in the media particularly when schemes were used by the famous.
In 2014, the singer Gary Barlow and fellow members of Take That, Howard Donald and Mark Owen, were ordered to repay millions of pounds of tax relief that they had received when investing in what was judged by a court to be tax avoidance schemes.
Other famous names that have attempted to utilise avoidance schemes include Jimmy Carr, Bear Grylls and the pop group Liberty X.
How can you legally pay less tax?
Putting all this aside for a moment, there still exist opportunities to legitimately reduce the amount of tax payable.
The best way to ensure that any tax mitigation scheme stays within the confines of the law is to utilise the actual laws and Acts of Parliament established by the government itself!
Investment Bonds
The first financial vehicle to highlight is an Investment Bond. This was established through The Chargeable Gains Act 1992 and later endorsed by the Income Tax Act 2005
An investment bond is a lump sum investment which allowsan investor to take a tax free ‘income’ from their capital while deferring any potential tax liability for many years, by which time they may be paying a lower rate of tax.
The ‘income’ is tax free and can be withdrawn by upto 5% of the value of the original investment each year.
If the 5% is not required, the 5% amount will cumulate so that after 5 years, 25% of the investment can be withdrawn tax free.
As an example, a £500,000 investment would provide an income of £25,000 per year. If the income is not required for say 5 years or even 10 years, the tax free sum of £125,000 or £250,000 could be received.
This vehicle is ideal for investing the proceeds of a business sale or property sale where a tax free income is required after the transaction.
The bond can be held in a trust structure which will be outside of the investors estate after 7 years for inheritance tax purposes.
Mitigating Income Tax and Capital Gains Tax
The Enterprise investment scheme was established by the government in 1981. The aim was to encourage private individuals to invest in unquoted companies.
Income tax relief is provided at the rate of 30% on investment in these shares up to £2m a year.
For high earners, this would provide a staggering £600,000 worth of Income tax relief, that can also be caried back to the previous years tax bill.
Effectively, this will wipeout the income tax liability at the rate of 30% of the value of the investment.
On the capital gains side, the growth of the shares are CGT free.
If an investor has a large capital gain liability from the sale of assets or other investments, the proceeds can be invested into the EIS to receive 100% CGT deferral. This is ideal for the sale of a rental property at a large profit.
Finally, holding the shares for at least 2 years will mean that they are exempt for inheritance tax.
These are just a small number of the tried and tested approaches to tax mitigation.
Next Steps
Taking advice from a regulated certified financial planner, who is authorised and regulated by the FCA, is the first step in establishing which approach is best for your own personal circumstances.
This will provide you with the assurance to know that any advice received is regulated by the FCA which will ensure the advice is appropriate for you.
If you would like to discuss your options, please contact me here Calendly – Marc Burman
The value of investments may fall as well as rise and a policyholder may not get back what they put in. This information is based on my interpretation of the law and HM Revenue and Customs practice as at June 2023. I believe this interpretation is correct, but cannot guarantee it.
Tax relief and the tax treatment of investment funds may change.
The value of any tax relief will depend on the investor’s individual circumstances.
This is not personalised advice, you should seek independent advice taking into account your personal circumstances.
