No need to overpay the taxman

TAX avoidance may be the target of another government crackdown, yet millions of people are giving too much money to HM Revenue & Customs because of missed opportunities to cut their tax spend.

Chancellor George Osborne described tax evasion and aggressive tax avoidance as “morally repugnant” in last month’s Budget speech as he outlined plans for a new anti-avoidance rule.

For the humble taxpayer, however, the new tax year presents a fresh chance to avoid giving the taxman more than necessary.

By failing to take advantage of allowances, benefits and credits, UK taxpayers will gift HMRC some £12.6 billion (£421 per taxpayer) more than they need to this year, according to unbiased.co.uk.

But the dawn of the 2012/13 tax year creates new opportunities to redress that balance.

New tax year measures that came into force on Friday will almost certainly have an impact on your finances.

While personal allowance increases taking effect last Friday and on 6 April next year will reduce the tax bill for many low and middle-income earners, thousands of Scottish families will be hit by restrictions on child benefit from next January.

Thousands of families on modest and middle incomes have also lost their child tax credit, while many working couples on less than around £17,000 a year are losing their working tax credit.

Other measures to take effect include the lowering of the lifetime allowance for pension funds from £1.8 million to £1.5m. Those breaching the limit and who haven’t taken steps to retain their £1.8m allowance face a 55 per cent tax charge when their benefits are taken.

Then there are cuts in the basic rate tax threshold, which leaves many middle-income Scots facing the 40 per cent tax rate for the first time.

The number of people in the higher-rate tax bracket is set to hit five million in the next two years, up from 3.7 million last year, the Institute for Fiscal Studies estimates.

But reducing the amount you give to HMRC each year isn’t a challenge only for those at risk of facing a higher tax rate. There are numerous ways of mitigating tax, many of which are straightforward yet very effective.

Here are a few:

Pension contributions

One option is to pay more into your pension or, if you don’t have one, to start contributing to one, whether a personal pension or in the workplace.

Keith Mackie, a certified financial planner at Acumen Financial Planning, explained that pension contributions can help increase the amount of income received at the basic rate.

“For example, say you earn £45,000: the amount over the £42,475 threshold is liable to tax at 40 per cent. However, a monthly pension contribution of £250 gross has the effect of keeping you outside the clutches of higher-rate tax,” he said.

Pension contributions can also help families retain their child benefit payments, which from next January will be phased out where at least one earner is on £50,000 or more, being removed entirely at £60,000.

The relevant figure will be the “adjusted net income”, meaning payments such as those to pensions and gift aid can reduce that net income.

Mackie said: “That means you could hold on to all of your child benefit if you make pension contributions or donations to charity to take the biggest earner’s net income below £50,000, while still obtaining higher-rate tax relief on these pension contributions and donations.”

Salary sacrifice

This is where you agree with your employer to exchange some of your salary for other benefits in order to reduce your taxable income.

The most common way of doing this is through pensions, although childcare vouchers are also popular.

For example, if you earn £43,000 a year (just in the higher-rate bracket), reducing your salary by £2,000 and allowing your employer to pay that £2,000 into your pension instead will allow you to remain in the basic rate band not only this year, but also when the threshold is lowered again next April.

But bear in mind that reducing your salary could have an adverse effect on payments based on the salary amount – such as maternity leave payments – and on transactions such as mortgages, personal loans and credit cards.

Tax-friendly investing

You can now save up to £11,280 a year in a tax-efficient Individual Savings Account (Isa) – including up to £5,640 tax-free in a cash Isa – following an increase in the annual allowance that took effect on Friday.

However, savers will miss out on more than £400m this year by failing to use their Isa allowances, according to the Tax Action report from unbiased.co.uk.

Other tax-efficient options tend to be aimed at investors happy to take a certain amount of risk in return for the potential for growth.

Income tax relief of 30 per cent is available on enterprise investment schemes (EISs) and venture capital trusts (VCTs), both of which are aimed at boosting investment in small companies, and the individual investment limit has been doubled to £5m, as of Friday.

VCTs and EISs offer inheritance tax and capital gains tax (CGT) benefits too, although they are suitable primarily for affluent, sophisticated investors due to the high risk level.

Use your allowance

The annual Isa entitlement is perhaps the most obvious, but there are others on offer. The CGT threshold remains frozen for the new tax year, but £10,600 in gains can still be taken before tax is charged at 18 per cent (if the taxable gains and income are below the basic rate limit) or 28 per cent.

One common oversight is a failure among married couples and civil partners to save tax by using each other’s unused CGT allowance.

Neil Mitchell, tax partner at Mazars in Edinburgh, said: “Where one spouse is paying higher-rate tax and the other does not utilise their full basic rate band, it is worth considering whether any balancing of income can take place.”

Check your tax code

Around one in six of the UK’s 30 million taxpayers paid the wrong amount of tax in the 2010-11 financial year as a result of being given the wrong tax codes.

Neil Whyte, tax partner at PKF in Edinburgh, recommends checking your tax code for the new tax year as soon as you receive it.

“Tax codes for 2012/13 have been recently sent to millions of people across the country, but most will have been automatically generated by HMRC’s computer systems and will not have been checked manually by tax officers – potentially resulting in significant numbers of taxpayers either underpaying or overpaying tax.”