It seems every few weeks you see the headline ‘Mr Super-Rich/Company X pays no tax or little to no tax on earnings’.
Usually, there’s a statement from the person/company that says ‘we have done nothing wrong, all of our affairs are above board and legal’ or something to that effect.
Most people we speak to agree with the statement that ‘the more money you have, the more you can pay the financial experts to structure your tax affairs accordingly. This kind of thing is exclusive to only a select few, the super rich’.
Here at Montage Wealth we know that is not the case, the legal loopholes and sophisticated investment vehicles are open to everyone. Plus they’re not as complicated as you may think.
Below we’ve laid out how you too can legally structure your assets and revenue in a way that will have your friends wondering how you got that bigger boat!!
So let’s dive in.
The Difference Between Asset & Income Wealth
While it’s true that some of the super-rich may use morally questionable methods to avoid paying taxes, that’s not what the majority do. What the majority of the mega-rich do is take advantage of all the legal loopholes and options available to see their taxes decrease.
But, before explaining the different structures the “super-rich” use, we first need to understand the definition of “super-rich better”. We believe that super-rich can be broken down into two categories:
- Asset rich – Those that have accumulated a vast amount of assets
- Income rich – Those that are working and are earning a very high level of income each year.
That is not to say the two are mutually exclusive; some are fortunate enough to be both. It is just that the source of wealth for the super-rich will determine the type of tax structure(s) used.
Asset Wealth – Insights & Options Of The Rich
For those that are asset rich, there are several tax considerations that they give when structuring their wealth, namely:
- The amount of tax they will have to pay on their assets growing in value, or the amount of tax payable on the interest and dividends these assets produce.
- The amount of tax their beneficiaries they will have to pay when they die.
To reduce the amount of tax they pay on their assets, there are several structures that the asset rich use to reduce their tax burden. Here are our top 5:
1. Offshore bonds – Offshore bonds are often used by the asset rich as a tax wrapper to invest their assets into. An offshore bond gives an investor the ability to earn fixed interest and dividends (as well as crystallise capital gains) gross of tax (i.e. no requirement to pay tax at the time). An investor should only have to pay tax at the time they wish to surrender the bond – by carefully managing the timing of this surrender, an investor can often reduce the overall tax payable. Offshore bonds also have the benefit that an investor can withdraw 5% of the initial investment value each year without paying any tax (until the eventual surrender).
2. Distributing assets between you and your spouse – rich married couples tend to split assets between spouses to make use of each of their respective tax allowances (such as Capital Gains Tax Allowance, Personal Allowance, Dividend Allowance, Personal Savings Allowance). Care must be given when transferring assets between spouses to ensure that this transfer does not count as a crystallisation for capital gains tax purposes.
3. Trusts – Trusts are often used by the asset rich to reduce inheritance tax liabilities on their estate when they die. Trusts are a fiduciary relationship in which the settlor (the person who puts assets into trust) gives the trustee(s) (the person/people who manage the trust), the right to hold title to assets for the benefit of the beneficiary. There are various types of trusts used by the rich. Trust planning is typically developed with a professional adviser, who would assess both the situation and needs and then recommend the most suitable trust(s) to match the objectives of the rich. For more details on trusts, please see the GOV.UK website https://www.gov.uk/trusts-taxes
4. Whole of life – Whilst trust planning can do a lot to mitigate inheritance tax liability, the asset rich do not typically like all their assets tied up in trusts. They, therefore, look to alternative methods to cover the inheritance tax liability due on their death(s). One way of covering the liability is by taking out Whole of Life cover. This is a type of insurance that pays out in the event of death, and the plan is in place for the remainder of the life of the person(s) insured. For married couples who leave everything to the surviving spouse and then to other beneficiaries, they would typically take out joint life, second death cover, as an inheritance tax bill would not be due until the death of the second spouse. These plans are typically written into trust so that they are outside of the estate and not subject to probate.
5. Diversification of assets – The rich tend to have a diverse portfolio of assets. The benefits of a diverse asset base aren’t so much for the benefit of tax mitigation (although having assets that generate a combination of capital growth, fixed interest income and dividend income does allow the rich to make use of all their tax allowances), but more for the benefits of reducing risk. Many rich have become rich thanks to heavy investment in one company/market/sector. Whilst it is difficult for us as humans to not maintain a bias towards something which has been so successful, the informed rich understand that it is good to reduce the exposure to one asset and diversify amongst other assets.
Income Wealth – Insights & Options Of The Rich
For those that are income rich, the main tax consideration that is given is with regards to income tax. The income rich are typically taxed at rates of 42% (40% income tax plus 2% National Insurance Contributions) for higher rate tax and 47% (45% income tax plus 2% National Insurance Contributions) for any earnings over £150,000.
Mitigating tax for the income rich is typically harder than for the asset rich, as there is less scope and flexibility in how income is received. Here are our top 5 tips
1. Pensions contributions – This is one of the simplest and easiest ways for the income rich to reduce their income tax liability. Tax relief is currently applied at the individuals marginal rate of tax. So, an additional rate taxpayer would receive 45% tax relief, this is typically 20% at source (which is paid into the pension on top of the net contribution) with a further 25% to be recuperated by the individual on completing their tax return. For example, if an additional rate taxpayer made a net pension contribution of £8,000, they would receive an additional £2,000 into their pension from HMRC (relief at source) and be able to claim a further £2,500 in tax relief via their self-assessment tax return. Individuals have a pension annual allowance which is the maximum they can invest into a pension each year (without being subject to the annual allowance tax charge). Individuals are also able to carry forward any unused pension allowances from the previous three tax years (provided they were a member of a pension scheme in these three years). The income rich typically seek professional advice to guide them as to how much they should invest into a pension each year.
2. Tax incentivised investments – For the income rich with a higher attitude to risk, there are several types of Tax Incentivised Investment Schemes. These schemes encourage the income rich to invest in young, unquoted trading companies. The schemes available are:
- Venture Capital Trust (VCT)
- Enterprise Investment Scheme (EIS)
- Seed Enterprise Investment Scheme (SEIS)
- Social Investment Tax Relief (SITR)
Each of these types of schemes offers income tax relief of 30% (except for SEIS which offers income tax relief of 50%). This means if, for example, £100,000 was invested into a VCT, an investor’s income tax bill for the tax year (or potentially the previous tax year if applicable) would reduce by £30,000. An investor must hold the investment for at least 3 years for an EIS, SEIS and SITR and for at least 5 years for a VCT. One of the key differences between a VCT and the other three schemes is that a VCT is an investment company which invests in a range of small companies, whereas an EIS, a SEIS and a SITR are typically an investment into one company at a time. Please bear in mind that these generous tax reliefs are offered by the Government given the very high-risk nature of such investments. For more details on these tax incentivised investments, please see the GOV.UK website https://www.gov.uk/guidance/venture-capital-schemes-tax-relief-for-investors
3. Remuneration restructure – Some of the income rich generate their high levels of income through their own business. Business owners with companies that generate a high level of revenue have a good degree of flexibility with respect to how to remunerate themselves. Business owners can pay themselves a combination of salary, dividends and employer pension contributions. If their spouse is involved in the business (and is a shareholder), they can also utilise their allowances with the same combination of salary, dividends and pension contributions. Individuals who have a highly successful business generating high levels of revenue should seek professional advice as to how best to extract profits from their business. However, it isn’t just business owners who can benefit from a remuneration restructure – employees have the potential to restructure their remuneration if their employer is willing. Employees can ask their employer if they allow salary sacrificing for their pension contributions (and allow the employee to receive the saved National Insurance contributions as additional pension contributions). An employee can also inquire as to whether their employer offers any Employee Share Schemes. Details of the types of Employee Share Schemes that are potentially offered by employers can be found on the GOV.UK website https://www.gov.uk/tax-employee-share-schemes
4. Gifting out of regular income (normal expenditure out of income exemption) – Gifting out of regular income makes no difference to an individual’s income tax bill, but it is a method used by the income rich to reduce the potential future inheritance tax bill. If an individual makes a gift to a beneficiary (in excess of their £3,000 annual gift allowance), then the gift is classed as either a Potentially Exempt Transfer or Chargeable Lifetime Transfer. These gifts will stay in an individual’s estate for at least 7 years after the gift is made. A gift out of regular income however immediately falls outside the estate of the individual making the gift. To qualify, the payment must be made from earned income, based on current income levels, there must be a consistent pattern to the gifting out of income, there must be no negative impact on the donor’s standard of living and there must be clear records kept documenting the regular gifts.
5. Charitable donations – One way the income rich reduce their income tax bill is by making donations to their preferred charities. To receive tax relief on a charitable donation, the charity must be eligible to receive gift aid. Gift Aid does not apply when you are donating in return for goods or services or donating on behalf of somebody else. The charity receives gift aid at the basic rate, and the donor can claim additional tax relief if their marginal rate of tax is a higher rate or additional rate tax. For example, if an individual donates £8,000 to charity, £2,000 will be claimed by the charity (meaning the charity receives a total donation of £10,000), the individual would then be able to claim a further £2,500 in tax relief via their self-assessment tax return.
As you can see there are numerous ways in which you can structure your wealth in a way that is more beneficial to you and your family.
Every person has a unique set of financial circumstances, requirements and goals and we hope this article gives you food for thought on how you can use the same available methods and strategies the super rich use!
If you have any questions regards the above or would like to see how we can help structure your individual wealth in a way that is tailored to your needs, then please click HERE.