HM Revenue and Customs (the new name for the Inland Revenue) has been levying income tax for more than 200 years and knows a thing or two about it!
It’s more or less true that tax avoidance is for the rich. It costs money to arrange your affairs to reduce taxation, so tax avoidance is only interesting in regimes where income tax is steeply progressive and you earn enough to be paying tax at the highest rates. This is one reason for the popularity of so-called flat tax rates in Central Europe – high earners have little incentive to avoid tax when it’s not progressive.
If your income comes from employment, there is very little scope for avoidance. HM Revenue has it pretty well pinned down. Even if your employer might be prepared to go along with a complex scheme, they might find themselves having to pay your tax themselves, and this discourages them!
However, some avoidance is available because the government encourages it. One of the simplest ways of reducing the tax burden is through paying extra into a pension scheme. You reduce your tax (within limits), but also lose access to the money paid into the pension scheme until you retire, so you need enough income for this not to be a problem. Another way is to invest in small businesses: government has promoted schemes to encourage this in the past.
Assuming you have income other than from a single full time employment (which rules out most people), you could look for more complex schemes, but then the next obstacle is knowledge. You have to find out about schemes, and this means paying fees to tax advisers, and being confident that they know what they’re talking about.
The nature of tax avoidance is such that an adviser may come up with a complex scheme but you cannot be certain that it is fireproof until it has been tested in court – which is not an experience you would enjoy. How do you know what adviser to talk to? KPMG, one of the world’s biggest networks of accountants, paid $500m in 2005 after selling illegal tax shelters.
As you move up the scale of complexity, avoidance schemes take advantage of the issues of territoriality and legal personality. Although there are bi-lateral tax agreements between many countries, taxation is essentially limited to activities in a particular territory, and subject to national statutes. If you have international transactions, you can try to organise things so that you do not fall into any tax net. This is a particularly interesting issue in electronic trading on the internet: whose territory does the transaction fall in?
"National tax authorities have an armoury of weapons"
However, you need to have either investment capital or income which comes from outside the UK, or you need to be resident in a tax haven such as Jersey. And of course, national tax authorities have an armoury of weapons to try to limit your opportunities. Equally the European Union has started to introduce tax cooperation arrangements between member states that provide for exchanges of information, and for tax to be deducted from investment income at source.
Taxation falls on individuals, but legal personality extends to companies: if you form a company and that company receives income, the company becomes a taxable person separate from you. Personal service companies were very popular in the UK, until HM Revenue started taking an interest. The company receives fees from selling the services of an individual, that individual then receives a salary from the company. The company can retain a proportion of the income and might use it to supply facilities and goods to the individual. The company will also pay a lower rate of corporate income tax than the marginal rate of 50% (40% tax and 10% national insurance) that the individual would pay on extra earnings.
"Can you be certain the Revenue is not going to come knocking on your door?"
There are generally some limited opportunities for tax avoidance (legal diminution of tax as opposed to evasion which is simply illegal) even in a mature tax system like that of the UK. However, even the simplest forms require you to have money available that you do not need right now.
The more complex forms mean that you will have to pay potentially substantial fees to advisers, so up to a certain level of income the tax saving will be less than the professional expenses. Finally there is always the question of knowledge and uncertainty. Finding out about schemes could have a high initial cost, and then can you be certain the Revenue is not going to come knocking on your door years later?
- Tax shelters – nobody likes paying tax – but how far would you go to avoid it?