There are many methods how to avoid income tax. Avoiding income tax is of great interest to many people in the UK. How do we know this? There are 301,000 searches on Google for the key term, “income tax” in the UK each month. Many of those searchers are looking at what they must pay but a huge percentage of these searchers are looking for ways to avoid, reduce or even eliminate income tax. Avoiding income tax is a key element in accelerating your wealth. The aim of this article is to show the reader that all the aforementioned options are possible in the UK through legal tax planning and tax avoidance methods.
To become eligible for tax planning in the UK, the bar is set rather high for most people due to the inherent cost of tax planning and tax avoidance methods. The entry level due to financial viability is usually set at an income in excess of £100,000 per annum for those who are not contractors. However contractors can viably access tax planning that will significantly reduce their income tax liability with an income of £50,000 per annum. Presently in the 2011/12 tax year the option for those on PAYE (Pay As You Earn) engaging in tax planning has been removed by the HMRC. This has meant that highly paid executives and salesmen are looking for new ways to be paid by their employers as they have effectively taken a large “hit” on their take home pay.
The methodology of income tax planning is rather simple but there are many ways how to avoid income tax and they are really only limited by the imagination, and of course current legislation. The two methods are either creating a paper loss in one area or then applying that loss to your income to reduce or eliminate your tax liability or alternatively to create your income in a tax free environment. Both these methods will now be explored and explained.
Generally speaking the loss method is created through an investment that is high risk, but a genuine investment with a very good upside. The fee for the tax planning/tax avoidance scheme varies but is often around the 20% mark and this is paid in cash while the full magnitude of the loss will be created by an interest free, unsecured loan that is structured so that it will not ever be paid back. The loan now gears your total investment significantly so that if the investment does not go as one would hope, the loss is equal to whatever amount of income you wish to reduce for tax purposes.
Often the areas of investment are in areas that will give a high positive outcome, although the probability of that outcome is low. These are often investments in software development, new technology, and a favourite in the UK has been the Film Industry with Film Partnership Schemes in the past. If the investment actually makes money, the additional cash will be taxed, but what is left over will more than adequately pay for your tax bill, making you much better off financially. More often than not the investment creates a loss and that is applied to your income and only what is left over after applying the loss, is taxed. Most people naturally construct their loss so that they pay no tax at all.
Sadly the process described above no longer works for those people on PAYE. Previously they would apply the loss to their PAYE income and receive a large rebate from the HMRC, but a change in legislation now prevents this. Those whom are self-employed are presently the only ones able to do this form or tax planning. Once the self-employed tax payer has applied the loss to his or her income on the tax return, the net result is zero income and no tax is paid.
Tax avoidance schemes like the one mentioned above are now disclosed to the HMRC on your tax return. This regulation is known as DOTAS, Disclosure of Tax Avoidance Schemes. This disclosure enables the HMRC to monitor the amount of tax they are losing due to a particular piece of legislation. If the amount of tax that is being lost is significant the HMRC will legislate against this in the following Government Budget announcement in March/April each year. At this point the UK’s leading tax experts then devise new schemes that overcome the new laws or exploit the new opportunities that changing one law will have on another.
The second method of how to avoid income tax that is most commonly used is ensuring that your income is created first of all, not in your own name and secondly, in the name of a tax structure that is based in a low tax or “no tax” jurisdiction. Obviously this is easier for self-employed people to do because altering the way you get paid requires the permission of those paying you. Once you have achieved this there are a number of ways of getting you tax-free earnings back into the UK without paying tax.
A method that recently changed due to a change in legislation was the use of the Employee Benefit Trust (EBT). We will examine this method as it was widely used and there are new structures that offer the same tax benefits. A company would set up a trust for the benefit of its’ key employees, which were usually high ranking company officers, share-holders, directors and owners. These people would have a declared income, which they would pay tax on with PAYE. The bonuses or profits that were due to these people were then transferred to the EBT. The company received a tax deduction for the cash that was transferred to the EBT so it paid a lot less corporation tax. The EBT had an individual sub-trust set up for each of the key employees. The cash due to each respective employee was then transferred to their sub-trust. The employee then accessed that cash in the form of loans. Loans are not income and are therefore not taxed, so the employee was able to avoid income tax as well. The loans were constructed in such a way so that they were also never paid back. The employee then had the additional benefit of being able to invest their cash from the sub-trust in a tax-free environment where it grew at a faster rate in the absence of tax. The Isle of Man was the preferred jurisdiction for an EBT.
There are now many other structures available for achieving the same result. One example is the EFRBS (Employer Funded Retirement Benefit Scheme II). This structure achieves what the EBT did and is subject to DOTAS. There are other structures that are not subject to DOTAS and they will therefore have greater longevity.
As you can see there are many ways how to avoid income tax and they tend to go hand in hand with ways that will also reduce corporation tax. Ultimately in the present economic climate, it is the self-employed or business owners that can avoid income tax the easiest. If you are a self-employed high earner, it will be well worth your while to have a free consultation with a UK tax expert and see how your life can be improved by avoiding income tax. Income tax planning will accelerate your wealth creation and bring your financial goals to fruition faster!