Eight Taxes To Avoid

As higher bills and rising taxes eat into our incomes, we come up with ways to pay less tax -- legally, of course!

"The avoidance of taxes is the only intellectual pursuit that carries any reward." (John Maynard Keynes)

Although nobody actually enjoys paying taxes, few people would claim that the UK would be better off without them. Without taxes to redistribute wealth throughout society, millions of people would have no access to essential public services such as education, healthcare, housing, security and so on.

Indeed, in many ways, the history of taxation is the history of civilised society. The ancient Greeks moaned about it; it forced Mary and Joseph to move to Bethlehem (where Jesus was supposedly born in a stable); and Lady Godiva allegedly rode naked on horseback through eleventh-century Coventry to convince her husband Leofric, Earl of Mercia, to decrease taxes on his tenants.

Over the centuries, taxes have also reflected the fashions of our nation. Land taxes were in existence throughout the last millennium and, as homes became larger, a window tax was introduced in 1696 and continued until 1851, which explains why some very old properties have bricked-up windows; and tobacco taxes were introduced by James I in the late 1500s (he called tobacco "that obnoxious weed").

However, British society fiercely resisted a tax on income, on the grounds that revealing one's personal income was vulgar, and that income tax represented an unacceptable government intrusion into one's private affairs and, therefore, an affront to personal liberty.

Britain managed to oppose income tax until 1799, when the then Prime Minister, William Pitt the Younger, introduced it as a temporary measure to help fund the war against France under Napoleon. It was applied at a rate of 10% on income from all sources above £60, with reductions on income up to £200. Although it was repealed and reintroduced on several occasions, this 'temporary measure' is still with us 207 years later!

That's enough on the history of taxation; let's now explore how we can reduce the personal taxes that we pay -- quite legally and at little or no expense. In alphabetical order, here are eight everyday taxes, together with tips on how to avoid or reduce them:

Capital Gains Tax (CGT)

You may be liable to CGT if you sell an asset for more than you paid for it, with a notable exception being your home (or 'principal private residence'). For example, if you buy 10,000 shares for £2 and sell them a year later for £3, you have made a capital gain of £10,000.

You can reduce your CGT bill by offsetting losses against gains, so it can be worth 'crystallising' a loss in order to offset gains elsewhere. Furthermore, everyone (including children) has an annual CGT allowance, which is £8,800 for the 2006/07 tax year. Thus, gains totalling less than £8,800 in the period from 6 April 2006 to 5 April 2007 will not incur any tax liability.

As transfers between spouses (or same-sex Civil Partners) do not trigger a tax liability, you can gift assets to your spouse in order to make use of his/her annual CGT allowance. Also, by spreading sales across separate tax years, you can take advantage of two or more CGT allowances. Using these two techniques, I helped a friend realise tax-free gains of over £40,000 on a company Sharesave scheme!

Personally, I avoid CGT worries by investing in shares inside an Individual Savings Account (ISA), which is a tax-free shelter inside which all capital gains and income go untaxed. Thanks to ISAs, my wife and I can invest £7,000 apiece into shares each tax year. Hurrah!

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Income Tax

It's quite hard to avoid income tax on earnings from employment, especially as it is deducted at source via the Pay As You Earn (PAYE) system for employees. However, everyone has an annual tax-free personal allowance, which is worth £5,035 in the 2006/07 tax year.

One simple way to reduce your taxable earnings and, therefore, your income tax is to contribute to a company or personal pension. Pension contributions attract tax relief at your highest rate, which means that a contribution of £100 costs a basic-rate (22%) taxpayer just £78, or a mere £60 for a higher-rate taxpayer. You can also earn income-tax relief on contributions to Venture Capital Trusts or Enterprise Investment Schemes, but these are high-risk investments into small businesses, which are best suited to sophisticated investors.

It's also worth taking steps to avoid tax on your savings interest. With an everyday, taxable savings account, taxpayers automatically lose a fifth (20%) of their pre-tax interest to the taxman. Higher-rate taxpayers have to hand over the same amount again, which means that they lose 40% of their savings interest to the taxman. The simplest way to avoid tax on savings is to make full use of the £3,000 per tax year that you can pay into a cash mini-ISA, which pays tax-free interest.

Inheritance Tax (IHT)

Although you may have been a basic-rate taxpayer for your entire life, you may find that your estate is taxed at 40% when you die. Although all estates have a nil-rate band on which no Inheritance Tax is charged (£285,000 in the 2006/07 tax year), the standard rate of IHT is 40% on the excess above this threshold. Hence, it pays to take steps to reduce your IHT while you're alive, so learn more by reading our guide to Wills, Probate and estate planning.

Insurance Premium Tax (IPT)

Insurance Premium Tax is levied on general insurance policies, such as car insurance, home (buildings and contents) insurance, travel insurance, the dreaded payment protection insurance, etc. There are two rates: the standard rate of 5% and the higher rate of 17.5%.

Most everyday protection policies attract IPT at 5%, but the higher rate of IPT is levied on all travel insurance policies, plus any car insurance policies and extended warranties on domestic/electrical appliances which are sold by the provider of the goods themselves.

So, if you want to reduce the IPT that you pay, don't buy insurance from retailers and car dealers, and lower your premiums by shopping around before buying insurance and again at renewal time.

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Motoring taxes

According to the AA Motoring Trust, excise duty and Value Added Tax (see below) typically account for roughly two-thirds (67%) of the cost of a litre of petrol or diesel. For example, here's a breakdown of a litre of petrol or diesel costing £1:

As you can see, excise duty and VAT account for 62p of the cost of our £1 litre of fuel; thanks to rising oil prices, this proportion has fallen from previous levels of 80% or so. If you'd like to slash your fuel bill and other motoring costs, read How To Beat Fuel At £1 A Litre.

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'Sin' taxes

The government loves to tax addictive habits, because they are so hard to give up and, hence, provide attractive, stable tax revenues! For example, the tobacco duty on a packet of twenty cigarettes amounts to 22% of the retail price, plus 10.51p per cigarette, plus VAT at 17.5% on the whole lot. Here's the breakdown of a packet costing £5.25:

Hence, £4.04 of our pack of twenty cigarettes costing £5.25, or 77%, goes to the government, making cigarettes one of the most highly taxed goods in the UK!

Although alcohol is taxed more lightly than tobacco, taxes account for around three-fifths of the cost of a bottle of spirits, more than half the cost of a bottle of wine, and around three-tenths of the cost of a pint of beer. Also, almost an eighth (12%) of all money staked on the National Lottery goes to the government in tax, making it a jackpot winner to the tune of £600 million a year!

The antidote to sin taxes is simple: cut back or give up! For example, after the World Cup finished on 9 July, I started another month of extreme budgeting. As part of my financial detox, I've stopped both drinking alcohol and smoking, which has helped me to save hundreds of pounds, plus I feel great, too!

Stamp duty

When you buy a property, you have to pay Stamp Duty Land Tax (SDLT) at the following rates:

Note that the highest rate of SDLT applies to the full value of a property, so the stamp duty on a property costing £250,000 is £2,500, but the tax on a property costing £250,001 triples to just over £7,500. So, to minimise your SDLT bill when buying a house, stay below the trigger thresholds and drive a hard bargain with the seller!

Also, when you buy stocks and shares, you pay 0.5% stamp duty on the value of each purchase, which comes to £1 for every £200 which you invest. I dodge this tax by investing in iShares, which are exchange traded funds based in Dublin, as I explained here.

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Value Added Tax (VAT)

Introduced in April 1973 at a standard rate of 10%, this tax on goods and services is now levied at 17.5% on VATable goods (or 5% on reduced-rate items such as domestic fuel supplies, child car seats and women's sanitary products).

The good news is that Britain has one of the lowest VAT rates in Europe, and the least widely applied. Books and newspapers, children's clothes, everyday food, funerals and public transport are all VAT-exempt, or 'zero-rated'. On the other hand, chocolate biscuits (but not Jaffa Cakes), crisps and snacks, and children's clothing which can be worn by small adults are all VATable.

VAT is a 'consumption' tax, so the more you spend, the more VAT you pay. Hence, by cutting back on your spending, particularly on luxury goods, treats and vices, you also reduce your contribution to the VAT coffers. Eating healthily helps to reduce your VAT bill, because many fatty or sugary treats are VATable. For example, potatoes are zero-rated, but potato snacks (such as crisps and chips) are VATable. Also, coffee, tea and milk are zero-rated, but fizzy drinks are VATable.

So, to avoid VAT, learn to spend less and budget more carefully!

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Many thanks to HM Revenue & Customs for its history of taxation.