Is tax planning legal or illegal in the UK? We look at the definition of tax planning, tax avoidance and tax evasion. Find out how you can benefit from legal tax planning.

Is tax planning legal?

Yes, tax planning is perfectly legal here in the UK. There are no laws saying you cannot plan your taxes and financial affairs to handle your tax liability better. That is so long as you don't try to disguise your income as something else or attempt to defraud HM Revenue and Customs.

As long as you are not attempting to avoid the taxes you are liable to pay; then you can plan your taxes to your heart's content. There are some very important differences between efficient tax planning and illegal tax evasion arrangements.

The most popular example can be found in the ownership of most limited companies. Given that everyone in the UK is permitted a tax-free Personal Allowance of up to £12,570 (as of the 2022/23 tax year), most company directors or owner-managers will pay themselves a salary of this size.

While this might not sound like much to live on, they top up their salary with dividends that are charged at a lower rate than Income Tax. This means their yearly income does not meet the minimum threshold for Income Tax payments, but they still take home enough money.

An introduction to tax planning

Essentially, tax planning is a legal process by which you can arrange your finances to reduce your tax liability. Tax efficiency is an essential tool for any business, from a small or medium enterprise to sole traders to large corporations.

The UK government even provides tax reliefs and other legitimate ways to reduce your tax liability legally, such as Tax Savings and other tax advantages. With the right tax planning, you can avoid straying into the more illicit worlds of trying to avoid paying tax and tax evasion.

One of the legal routes you can take to reduce tax liability includes choosing an early year-end date within the tax year for commercial purposes. This reduces the period between earning profits and submitting and paying taxes. You might also want to consider the various instruments that help you protect your appreciating assets from Inheritance Tax, such as funds or trusts.

Tax evasion is a completely different set of illegal tools which people use to reduce the tax paid to Her Majesty's Revenue and Customs. These can include claiming inaccurate earnings through self-assessment tax returns or hiding your income for tax purposes. Doing any of these can land you in serious trouble and lead to criminal prosecution in court. This is why many people choose to hire tax experts to help them avoid falling foul of the sometimes unclear UK tax rules.

What do we mean by tax planning, tax avoidance and tax evasion?

Most people have an opinion on the giant global corporations that arrange their business structures to reduce the amount of tax they pay as much as possible. Depending on which side of the fence you sit on, you'll have a different opinion about what should be done about them. 

But what about other people who want to reduce their tax liability? Determining the difference between tax planning, tax avoidance, and tax evasion will help us get a better idea of what we are talking about.

• Tax Planning - This is the legal process by which you can arrange your financial situation to reduce your tax liability. Some examples include making use of tax allowances, reliefs or saving for your retirement.
• Tax Avoidance - While not illegal, this method of reducing your tax bills takes advantage of specific loopholes and workarounds involved within the tax code to reduce your exposure. Again, it is within the law, but it is considered a very aggressive form of tax planning.
• Tax Evasion - This is an entirely illegal method of reducing your tax liability. Through these methods, individuals or businesses will try to avoid tax liabilities altogether. The most common taxes they evade include Income Tax, Corporation Tax, Capital Gains Tax, Stamp Duty and National Insurance Contributions (NICs).

Inheritance tax and dementia tax

Inheritance Tax is one of the main taxes here in the UK, besides Income Tax, Council Tax, VAT, and National Insurance Contributions. Again, opinions on this tax divide opinion widely, such as those who believe it is simply a double tax, given that the assets it taxes will already have undergone taxation through Income Tax.

On the other hand, some believe it is a way for wealthy individuals to pay their fair share when inheriting vast amounts of assets from their relatives.

In more extreme cases, those opposed to the wealthy becoming even wealthier believe that a progressive inheritance tax is a way to keep society relatively balanced and avoid too much privilege and power being passed into smaller groups through the generations.

Generally speaking, we have people like Gary Barlow and Jimmy Carr and their tax avoidance schemes, only available to the very wealthy, to thank for the amount of opinion flying around about UK tax laws.

However, it isn't cases like these that influence how the wealthy manage their tax planning. Current trends in the housing market, with prices soaring year on year, means that more people now than ever before are being pushed into the upper threshold for inheritance tax. This threshold currently stands at £325,000, with estates valued over this being taxed.

Therefore, with more people needing to pay taxes like Inheritance Tax, efficient tax planning is becoming increasingly important for more and more people.  This threshold was established back in 2019, but even in the three years since then, house prices have increased dramatically. 

With more people being caught in the inheritance tax net, it is unsurprising to find that in 2021, HMRC raked in nearly £6 billion through inheritance tax alone.  Another increasing worry for UK taxpayers is care home fees. Since care homes provide services for a large proportion of older adults in the UK, it makes sense that people are worried about their hard-earned money disappearing into these fees.

Additionally, a "Dementia Tax" has developed in the UK, with the Alzheimer's Society estimating that care costs for an individual with dementia run to nearly £100,000 per year, significantly drawing on people's private savings and assets.

Avoidance or tax planning?

Again, while tax avoidance is still legal, it is considered a very aggressive way to arrange your finances regarding your tax liability. While it isn't as serious as tax evasion, it is still frowned upon by most people. This is because tax avoidance schemes look to find omissions or different interpretations of the UK tax system to reduce the amount of tax someone pays. So while it may seem like a conniving thing to do, depending on your own opinions, it's entirely legal.

Many accountants and tax advisors spend their time pouring over tax law to exploit gaps or loopholes in order to help their clients. The individuals or companies these professionals provide advice to can then benefit from the vagueness or interpretations of the law to reduce their tax liability.

Taking advantage of the loopholes they find allows them to form bespoke interpretations of tax law or find inconsistencies or conflicts between different regulations. These can apply to all types of tax, including Income Tax and Capital Gains Tax.  However, HMRC is always trying to cut down on tax avoidance schemes and create anti-avoidance measures within the financial sector.

In 2009 they introduced the Code of Practice on Taxation for Banks. This code essentially tried to change the attitudes of those working in the banking industry and other organisations, discouraging them from either helping, promoting or facilitating tax avoidance schemes.  This was followed by the 2015 Budget, which aimed to establish more robust standards in business, as outlined by the UK government and HMRC.

The Budget tasked government agents and regulatory bodies to establish these standards in financial industries to dissuade people from being drawn into tax avoidance schemes. As a result, many professional accountants updated their codes of practice, with the Professional Conduct in Relation to Taxation improving acceptable tax planning standards.

HMRC itself is also trying to create more robust sanctions, harsher penalties and tax consequences for those organisations that either promote or facilitate tax avoidance schemes to the public.

The UK government has also stepped in to reinforce the notions the legislation was trying to establish when it was first drafted. Essentially they are tidying up the vague areas in the UK tax code that people have previously been exploiting in order to tackle tax avoidance.

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