TAX
AVOIDANCE – THE LEGAL WAY TO PAY LESS TAX
20
Keep Up to Date in Dealing
with the Taxman
Aim to
comply with the time limits set by the Inland Revenue. If you don't, money
you might have used for investment is frittered away on interest and penalties.
Submit
your tax return on time. If your 2002-03 return reaches the Revenue by 30
September 2003 you can ask them to work out your tax liability. And if this
is under £2,000 they can collect this through PAYE.
If you
delay submitting your tax return until after 31 January 2004, you'll pay a
fixed fine of £100 and another £100 penalty if you delay beyond
31 July 2004. But it does not end there. You can be fined up to £60 a
day if you go on procrastinating.
There are
many other penalties the taxman may charge and you should avoid them all.
Interest charged on the late payment of tax is an unnecessary drain on your
resources.
Your income
and capital gains tax normally has to be paid by 31 January following the
tax year, with equal payments on account on 31 January and the following 31
July during the tax year. By 28 February and 31 July in the next tax year
further 5 per cent surcharges will be levied on any tax you have still failed
to pay.
21
Claim
All the Tax Allowances You're Entitled to Have
Tax avoidance
is the term used to cover all the ways you can perfectly legally use to pay
less tax. Tax evasion is altogether different – it's being dishonest
in order to pay less tax, and as such is a criminal offence for which the
punishments are severe.
But it's
important to realise that even though you may be entitled to all sorts of
tax allowances and refunds, in most cases you won't get them unless you ask
for them. So you need to be aware of what you're entitled to and to put in
a claim. You can't, for instance, assume your tax coding is correct nor that
if an error is made, the Inland Revenue will point it out to you. You
can back track over the past five tax years as well as the current tax year.
You're also entitled to tax free interest on tax which is refunded to you.
This applies from the end of the tax year following the one to which the rebate
relates. So you may be able to claim substantial tax refunds plus interest
on allowances you haven't claimed in the past.
Your tax
position will vary according to your individual circumstances. There are
different rules, for instance, for self-employed people and for employees.
The situation changes if you're married, particularly if one of you isn't
earning, if you have a high income and if you have children. Read on to
find
specific examples which may apply to you.
22
If
You're an Employee, Check Your Tax
Review your
pay-as-you-earn (PAYE) deductions at least once a year. One easy way to
check your entitlements is to ask your tax office for a tax return. Read
the notes which accompany this carefully so that you remember to include
all the relevant allowances.
The
Inland Revenue produce an instruction to your employer called a "Notice
of Coding", which is used as the basis for making deductions from your pay.
You'll receive a copy with an explanation of the calculations. Examine it
carefully. If you don't receive one each year, remember to ask for it to
be sent to you.
If your
deductions are not being made on the basis of a correct Notice of Coding,
it is possible that your employer is deducting more tax than necessary.
Check this with your tax office and ask for the appropriate form so that
you can apply for a correct coding.
If you have
a company car and your employer pays for any of your private petrol,
check the current fuel scale charges. You may find changing to a car with
a slightly smaller engine will save you a lot of tax – or you may even
be better off paying for your own petrol in exchange for a pay rise equal
to what your employer is currently paying you for your petrol.
23
Participate
in Share Incentive Plans if You are Eligible
Share
Incentive Plans were introduced in July 2000. They have valuable tax benefits
so if your employer offers such a scheme, accept it with open arms.
Your employer
may give you up to £3,000 worth of shares in the company each year,
entirely free of income tax and National Insurance Contributions.
In addition,
a "partnership plan" allows you to buy shares worth up to £1,500 each
year from your pre-tax salary and your employer can match this by giving you
up to two free shares for each one you buy.
So if you
are a higher rate taxpayer you may buy up to £1,500 worth of shares at
a net cost to you of only £900, and if your employer wishes, you could
end up with a further £6,000 worth of free shares. Getting £7,500
for £900 (or £1,170 if you are a basic rate taxpayer) is like being
offered a £20 note in exchange for a fiver.
All shares
staying in the plan for five years will be free of income tax, capital gains
tax and National Insurance Contributions. If you sell your shares after
the five years are up, you will only be liable to capital gains tax on any
increase in their value after they come out of the
plan.
24
Don't
Forget to Claim Your Expenses
If you
run your own business or are a partner in a business you'll be allowed against
income all your business expenses including a proportion of the costs of running
your home (if, to some extent, you run your business from there) and the business
proportion of car travel (but not costs of travel from home to place of work
– unless your home is your office).
Here's
how to make the claim for part of the costs of running your home. First calculate
the number of bedrooms and public rooms in the house – omitting kitchen
and bathroom. Then total the costs of running the house – rent and water
rate, heat and light, cleaning, repairs and maintenance. If one out of six
rooms is used for work, perhaps as an office or study, then calculate one-sixth
of the total of expenses. It's best if the room is used occasionally for purposes
other than business, in which case you'd claim a percentage only of the calculated
sixth. This is because if the room is used exclusively for business
you may lose part of the capital gains tax free status of your home when you
sell it.
It makes
sense to claim these expenses if your case seems appropriate, as an Inspector
of Taxes can only say no. It is also true that in a grey area, one Inspector
may give an allowance where another would not – so it is always worth
having a go.
Here's
a checklist of expenses to include:
use of home as office
travel
expenses
interest on allowable loans
stationery, postage
telephone
books
subscriptions to professional journals
tools
necessary clothing
business losses if any
capital allowances as a proportion of original cost (check with your accountant).
Include purchases of equipment, machinery and vehicles
deduct profit from the sale of capital goods from capital allowances
If you're
an employee then there is a special rule about expenses which restricts the
kind of expense you can claim. The rule is that the expense must be "necessarily"
incurred – it is not possible to do this job without incurring this expense.
So a salesman
is able to claim petrol and other car expenses; a journalist can claim the
cost of paper and disks for his word-processor; a professional musician is
able to claim the costs of repairs to his instrument, music, strings and reeds
and so on.
An allowance
called a capital allowance is also available for capital expenditure which
is once again "necessarily" incurred – for example, the salesman's car,
the journalist's word-processor, the musician's instrument. Interest on loans
(not overdrafts) to purchase "necessary" items is also deductible.
In some
cases a trade association or union will have agreed with the Inland Revenue
the allowability of the amount or the nature of expenses which may be deducted.
For example the Musicians Union has agreed the amount deductible for categories
of orchestral musicians and the Association of University Teachers has agreed
that the costs of a study in a university teacher's home are deductible. Check
whether an example of this kind may apply to you.
25
Use Your
Capital Gains Tax Allowance
Everyone
is entitled to make some capital gains each year without having to pay any
capital gains tax (CGT). The allowance for 2002-03 is £7,700. A capital
gain is the profit you make by selling assets for more than you paid for them.
Any gains above this £7,700 are added to your income and taxed at 40
per cent if your taxable income plus gains exceed £29,900, 20 per cent
below £29,900 and only 10 per cent below £1,920.
For gains
made after April 1998 a taper relief system reduces the chargeable gain for
assets held for more than three years.
Besides
the capital gains tax allowance, look out for these other exemptions:
26
Make
Use of Indexation and Taper Relief
In calculating
your capital gain, when you sell or give away property or shares acquired
before April 1998, a deduction can be made for indexation relief. This is
calculated by applying the increase in the Retail Price Index (RPI) up to
April 1998 to the value of the asset when you acquired it (or its value on
31 March 1982 if you acquired the asset before that date). The effect is that
any increase in value which results from general inflation during that period
is tax free.
This is
a valuable relief when you compare the situation with, for example, a normal
investment in a building society. Interest of say 10 per cent gross would
be taxable at 20 per cent for a basic rate taxpayer, providing a return of
8 per cent. An investment in unit trusts on which you realise a gain of 10
per cent will be totally tax free if your total gains come to less than £7,700
in 2002-03 and may still be all or partially tax free even if you are above
the limit, depending on the RPI over the period of ownership.
A taper
relief system also applies to assets held after April 1998. This reduces the
chargeable gain depending on the length of time after April 1998 the asset
has been held. The maximum reduction in the gain chargeable is 60 per cent
for a non-business asset held for 10 years or more after April 1998.
27 Make
Sure You Don't Pay Hidden Tax on Investments
To maximise
your net return from investment schemes such as unit trusts or insurance bonds,
you will need to consider not only your own tax liability on any profits or
gains but also the tax paid by the fund manager.
Unit and
investment trust managers do not have to pay capital gains tax on the sale
of investments within the fund. You won't be liable to tax on any gains on
the sale of units unless you have used up your capital gains tax exemption.
With an
insurance bond, however, the insurance company has to pay tax on any gains
within the bond. Even if you do not have to pay any further tax on the profits
from the investment, your net return will of course be reduced by the tax
already paid.
Conclusion:
If you do not normally use your capital gains tax exemption, you may be better
off with unit or investment trusts than insurance bonds, depending on the
net rate of return. Saving on tax contributes towards your £2,000 investment
nest egg.
28 Children
Have Tax Allowances Too
If you
have children, you may be surprised to learn that there are many ways in which
the tax laws can affect them long before they start earning. Being aware of
the rules can enable you to make substantial tax savings.
First,
your children have a personal allowance just as you do. For 2002-03 it is
£4,615. This applies to any income they may have from investments as
well as any earnings. But it's not possible for you as a parent to give substantial
sums to your children for them to invest simply in order to use their tax
allowance. Other people such as grandparents may do this but not the parents
themselves as any income will be taxed as theirs.
There is
an exception to this rule, though. Up to £100 in each tax year which
a child earns as a result of a parent's gift will be treated as the child's
own income. But if the sum goes over £100, then all the income is treated
as that of the parent. So do your calculations carefully. Note though that
National Savings & Investments Children's Bonus Bonds are exempt from
this rule.
There's
a further disadvantage if you go over the £100 limit. If this represents
interest from a bank or building society, your child may not be able to receive
the income gross, without deduction of tax. This is because the income will
be treated as yours. So, unless you're a non taxpayer you'll not be able to
make the appropriate certification to the bank or building society. There's
more on this subject later.
Children
also have a capital gains tax allowance – £7,700 for 2002-03.
As you've seen, if you make a gift of shares to your children, you will
be responsible for paying tax on the dividends, unless they're below £100
in each tax year (when taken with any other income the child has as a result
of your gifts). But the capital gains are tax free up to the exemption limit,
regardless of the origin of the capital used to buy the
investments.
29
How
the Government May Contribute to Your Individual Pension
The decisions
you make about what kind of pension you need will depend on your individual
circumstances. You may choose whether to join or stay in your occupational
scheme, for example, or to take out an individual pension plan.
If you
work for an employer you may also be able to choose whether to contract out
of the State Second Pension – S2P for short. This provides an extra pension
on top of the basic State pension if you've made additional National Insurance
Contributions related to your earnings. If you already belong to an employer's
scheme which is contracted out of S2P, it won't apply to you. Your occupational
pension scheme will provide benefits which must be no worse than the state
scheme. If you're self-employed, you can't contribute to S2P unless you have
formed yourself into a limited company.
The government
is encouraging people to "opt out" of S2P. The incentive is that some of your
contributions are diverted from the Department for Work and Pensions (DWP)
into an approved personal pension plan of your choice. The amount depends
on your age and how much you earn. In 2002-03 if you earn £10,000 the
annual rebate ranges from nearly £159 for a 15 year old to over £640
for a 52 year old. You will get the maximum rebate of £2,746 if you are
aged 52 or more and earn £30,420 or more.
Working
out whether it makes sense to contract out of S2P is difficult because it
doesn't just depend on future inflation rates and investment returns. It
also depends on whether future governments change the entitlement rules
– the government is already planning changes to the State Second Pension
in 2005-06, to make it a worse deal for higher income earners.
If you
do contract out of S2P, you don't have to make any further contributions
to the private individual pension plan unless you choose to. But if you
do, you'll get full tax relief on your payments up to set limits at your
highest rate of tax. This means that for higher rate taxpayers, the Inland
Revenue will give back £40 for every £100 of your gross earnings
you pay in. Basic rate taxpayers get back £22 in 2002-03 for every
£100 they contribute.
30
Why
Pensions Are One of the Best Tax Breaks Around
If you're
making contributions to a personal or stakeholder pension, make sure the taxman
knows. You're entitled to tax relief at your highest rate on every pound you
contribute up to a maximum level. What's more, the pension fund itself pays
no tax on its capital gains, nor its dividend and other investment income.
On retirement, you can take a tax free lump sum as part of your pension up
to a set limit.
You can
also make savings on the provision
of life cover if this forms part of your pension policy. For schemes started
after April 2001, you're entitled to full tax relief at your highest rate
on the premiums – the same tax relief you get on your pension contributions
– providing they don't exceed 10 per cent of your total contributions.
For schemes created before this date, tax relief is given at your highest
rate providing the life's premiums don't exceed 5 per cent of your total
pensionable earnings. If you're in a company pension scheme, you're not
allowed this option as an individual, though the scheme may cover you. But
if you are still contributing to a life assurance policy taken out before
1984, you will still be getting some tax relief.
Payments
made out of taxed income
to personal
or stakeholder pension
plans are topped up by the taxman at the basic rate of tax (22 per cent).
So, for example, if you pay in £7,800 the taxman will make an additional
payment of £2,200 to the pension company making a total investment
of £10,000. If you are over 50, you may if you wish cash in a quarter
of the fund tax free immediately. So, for a £10,000 fund, you would
be left with a £7,500 investment at a net cost to you of £5,300
(£7,800 minus £2,500). Higher rate (40 per cent) taxpayers get
an extra £3,000 tax relief by claiming it back on their tax return.
Most individual pension plans require the remaining funds (£7,500 in
the above example) to be used to purchase an annuity to generate an annual
pension for life. Whether or not this will be advantageous will depend largely
on annuity rates at the time you invest and also on the form you want the
pension to take. For example, you may want it to be increased each year
rather than be fixed. You may want the pension to be paid to your spouse
in the event of your death. These additional benefits cost money and reduce
the amount of your initial pension.
If you're
considering this because of the tax advantages, consult an accountant for
advice before making a decision. It's important to realise that you can't
change your mind about an annuity – once you've invested in it you can't
get your lump sum back.
31 Offset
Business Losses from a Hobby Against Your Income from Employment
You may
have an expensive hobby which has reached a point where it could be considered
a business by the taxman – for example, buying and selling valuable books
or paintings or photography or writing articles involving expensive research
or travel.
If so,
any losses you make in the first years of the business can be deducted from
taxable income in the past three years and the tax repaid to you with a
tax free repayment supplement. Business losses would arise after charging,
among other things, use of your home for business purposes (if appropriate),
an allowance for business equipment and the business proportion of any
motoring expenses. Your losses could then be set against your income from
full-time employment.
This way
you keep your hobby going, but have some tax savings to finance your investment
programme too.
32
Ask for a Tax Free Golden Handshake if You're Made Redundant
If you're
made redundant, your employer may suggest that you continue working for a
time in the hope that you'll find another job before you leave. But if you
leave straight away with a "golden handshake" as compensation for loss of
office, you and your employer gain financially.
You pay
no income tax or National Insurance Contributions on the first £30,000
of your redundancy pay. There are two exceptions to this rule:
REFS is
a mine of invaluable information for the private investor.
