There are two ways to pay less tax: tax avoidance and tax evasion. Confusingly similar sounding, but while one is perfectly legal and above board, the other could see you fined or in prison!
Tax avoidance is legal, and is essentially using tax rules in order to pay less tax.
Tax evasion is illegal, and is used to describe the act of breaking tax laws. Common forms of tax evasion include hiding taxable assets or simply lying to HMRC.
Just to be clear, we would never condone tax evasion! In this blog we look at completely legitimate ways to reduce your tax bill. So how can you legally avoid tax?
1. Dodge VAT (legally)
VAT (Value Added Tax) is sales tax which is added to the purchase price of most goods and services, currently at a rate of 20% in the UK. However, it’s not charged on everything and the laws behind it have become bafflingly complex over the years. For example, VAT is charged on biscuits, but rather oddly not on cakes. So what about Jaffa Cakes? Well the manufacturer successfully argued in court that they’re cakes and not biscuits, so their purchase price does not include VAT – switch cookies for Jaffa Cakes then, and you’ll be paying less in tax.
Other VAT-free goods include books, caravans and children’s clothing.
2. Move to Monaco
It’s no secret that income tax can make a serious dent in your earnings. In the UK, most people can generally earn up to £10,600 tax free, but after that you pay 20% income tax on anything up to £42,385, 40% on income above that and 45% if you’re fortunate enough to earn more than £150,000.
In Monaco, by contrast, residents pay no income tax. That’s right – in theory at least, you can earn an unlimited amount and not pay a penny (or a cent) in income tax. It’s sunny there, too! So what’s the catch? Well, apart from the exorbitant costs of owning a property there, you’ll also need to demonstrate substantial wealth to qualify for a long-term visa and be comfortable living life as a tax exile.
3. Pay into a pension
What some might consider to be the most boring way to reduce tax also has the potential to be the most effective. Pay into your pension and the Government will give you tax relief, adding to your contributions at your highest rate of income tax. Of course, there are catches (you can’t access the money until you are at least 55 years old, and generally, money is taxed as income when you withdraw from your pension) but for most people, saving into a pension will probably turn out to be one of the most effective and sensible tax-reduction plans out there. Find out more about pensions here.
4. Give to charity
To encourage charitable giving, the Government allows tax to be claimed back on donations. This usually means that the charity you donate to can claim an additional 25%, through Gift Aid. However, if you’re a higher-rate taxpayer, at the end of the tax year you can also claim back the rest of the tax you’ve paid on the donation via your self-assessment form.
5. Rent out a room
If you rent out a spare room in your home, not only will you earn extra income but up to £4,250 of that income will be tax-free, each year.
6. Save on road tax
The amount that you pay on road tax (officially known as Vehicle Excise Duty or VED) is dependent on the type of car that you drive. Generally, more fuel efficient and cleaner cars incur less road tax – owners of cars in band A, which includes certain models of the Nissan Leaf, Toyota Prius and VW Golf, pay zero road tax until April 2017. If you fancy something a bit more exciting, the same rule applies to any vehicle manufactured before 1 January 1974, so you could snap up a classic car – even a vintage Jaguar E-Type - and avoid road tax indefinitely (you might have to make up for it in mechanic’s bills though).
7. Premium bonds
Premium bonds don’t pay interest. Instead, the bonds you own enter a monthly prize draw, with a top prize of £1m. However, the real amount you’re likely to win is much smaller than that – they pay out at an average of 1.35% per year, and you can easily go years without winning a prize at all if you only own a small number of bonds.
If you win though, you won’t pay tax on your prize – not bad if you’re the lucky winner of a £1m jackpot.
8. Open an ISA
Earnings are usually taxed, and that includes money you earn in interest from savings and investment products: you pay tax on interest you receive from bank accounts, stocks and shares and investments including through marketplace lending platforms like RateSetter. However, any money invested via an Individual Savings Account (ISA) earns interest free of tax.
Until now there have been two categories of ISA, cash and stock and shares. But the introduction of the Innovative Finance ISA from 6 April 2016 means you’ll also be able to earn interest tax-free when investing through marketplace lending platforms. If you’re a higher rate taxpayer using the full allowance then we estimate you could save as much as £376 of tax in the first year alone, so head over to our IF ISA page for more information.