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{ in·deed·a·bly }

adverb: to competently express interest, surprise, disbelief, or contempt

Taxing

There are times when all seems right in the world. Calm. Serene. Blissfully idyllic.

This was not one of those times.

It was the filing deadline for self-assessment tax returns. An event as predictable as daylight savings. Yet, like daylight savings, an event that somehow manages to catch out hordes of otherwise seemingly intelligent individuals year after year.

A person’s attitude towards tax is an interesting barometer of their character.

Intellectually, most of us recognise taxation as a core part of the societal contract.

Built upon the understanding that if we each contribute when we can, then society will step in to help us out when we are unable to help ourselves.

Taxation provides the funding for the public services that we all rely upon in our everyday lives. Schools. Hospitals. Public transport. Roads. Police. Firefighters. Garbage collectors.

Yet many of us don’t much like the idea of actually paying tax.

Concurrently believing tax is a burden that should be borne by everyone, while also believing that our own personal burden should be actively minimised up to the put where avoidance becomes evasion.

My father used to resent every dollar he paid in tax.

Viewing each one as a personal failing, for not conducting his affairs in a more tax-efficient manner.

He would salary sacrifice into his pension to avoid paying income tax. Operate rental properties at a paper loss rather than pay tax on rental income. Use leverage to ensure dividend income was offset by tax credits and financing costs. Avoid selling profitable investments, as the mere thought of paying tax on a realised capital gain cancelled out any joy at having made a successful investment.

An objective observer might have questioned whether these behaviours made financial sense?

Arranging his affairs with the primary goal of minimising taxable cash flows. As a consequence, his portfolio was entirely tilted towards future capital growth, while ensuring the holding costs were self-funding.   

Yet in the game my father was playing, any time the taxman was denied the opportunity to pick his pocket, represented a clear win worthy of celebration.

Despite all that, when the time came he was more than happy to accept a pensioner’s concession card, and vast public healthcare subsidies on the eye-wateringly expensive life-extending chemotherapy drugs that would have otherwise bankrupted him had he been required to pay list price.

Ambush

Today, that burden of taxation appeared to fall on one particular unsuspecting victim.

One who baited the panic monster by leaving the preparation of their tax return until the very last day.

Hours of frantic activity were spent attempting to document a whole year’s worth of financial activities.

Scrounging up unfiled notices and statements. Receipts. Records of charitable donations.

Resetting long-forgotten passwords to fintech apps and seldom visited brokerage websites.

Compensating for a year’s worth of apathy and neglect with a flurry of expletive-laden activity.

Numbers painstakingly gathered. Aggregated. Curated. Massaged. Spun. Teased. Tortured.

Carefully keyed into the tax authority website, via a truly awful user interface. One that could only have been “designed” by some combination of an evil cartoon bad guy, a committee of indecisive egotistical senior executives, or a consultancy administered series of iterative A/B tests.

Finally, it was done.

With trembling fingers, sweaty palms, closed eyes, clenched buttocks, churning stomach, and no small amount of trepidation they hit submit.

Progress indicators span. And span. And span. A cheap programming trick designed to distract the punters, as behind the scenes undercooked IT infrastructure creaked and groaned under the load it was being subjected to.

Aeons passed. Moments before the user lost the faith and hit refresh, the website returned a result.

The calculated amount of tax owed.

A number.

A big number.

A number greater than that received per year by old aged pensioners and universal credit recipients.

A number only slightly less than the annual median household disposable income.

An involuntary howl of anguish erupted from the throat of the taxpayer. Tears sprang from their eyes. Bowels turned to water. Stomach acid churned. A little bit of vomit crept into the back of their mouth.

The dawning realisation that things were far worse than they had initially appeared to be.

Not only had the tax authorities already laid claim to a vast portion of the taxpayer’s hard-earned income from throughout the year, but the tax owed calculation significantly exceeded what their employer had diligently been deducting from each pay packet.

For once, the employer was not at fault.

How could they know about any dividend, interest, rent, or royalty income that their employees might happen to have earned? Nor were they aware of any entrepreneurial earnings, ranging from genuine business ownership through to the scammiest of side hustles.

As the taxpayer carefully reread their tax assessment notice on the screen, things only got worse.

They desperately sought to find a mistake. A waiver. A miracle!

Instead, they discovered that not only did they owe a five-figure sum on their extracurricular earnings, they had also been charged interest for failing to have already provisionally paid a material portion of that amount.

The tax authorities demanded immediate payment of half the outstanding amount.

The second half was due by the end of January, just 13 short weeks away.

To the taxpayer’s increasing horror, a third half was demanded by the following July, in anticipation of next year’s similarly sized tax bill.

There was just one problem. The taxpayer didn’t happen to have a spare £10,000 stashed in a winter coat pocket or stuffed down the back of the couch cushions.

In fact, they didn’t have a spare £10,000 at all. Not to mention the multiple instances of such a figure, which the tax authorities had decided they were entitled to.

Instead, those amounts would need to be saved out of future after-tax employment earnings.

Alternatively, the taxes could be met via the sale of those same hard-won income-producing assets. Assets purchased from after-tax income. Sacrificing the goose that lays a recurring stream of golden eggs to meet a one-off outgoing.

An act that would incur even more taxation, on the resulting capital gains.

At this point, readers may be tempted to cue the tiny violins. Feeling little sympathy for someone with sufficient means to generate investment income in the thousands. Particularly one who lacked the foresight and common sense to have budgeted for the inevitable tax bill that must surely follow.

A valid criticism. However, before you pass judgement and the social justice warriors amongst you start frothing at the mouth and screaming accusations of “privilege” at your screens, spare a thought for the plight of the disorganised taxpayer.

In the United Kingdom, there exists an archaic and often bizarre tax system that is littered with traps, pitfalls, and inequity for the unwary. One such trap is what happens when a taxpayer’s pre-tax income creeps above £100,000 per year.

At that point, every additional £1 earned is subject to 40% income tax. No surprises there.

However, at that point every additional £2 earned also causes the taxpayer’s tax-free threshold to be clawed back by £1. What does that mean in practice? Each additional £1 earned over £100,000 is effectively being taxed at a rate of 60%.

While the taxpayer’s salary remained below that magic £100,000 threshold, their taxable passive income streams pushed them above it. Not only was the taxpayer liable for the income tax due on their investment earnings, but they were also on the hook for the additional tax due on their salary as a result of that reduction in tax-free threshold.

The result was the eye-watering sum that was now due.

An objective observer might remark that (generally) people only pay tax when they’ve made money.

That even after the tax has been paid, they are still financially ahead of where they would otherwise have been, had they not made the investment.

For the most part, that is true, though your mileage may vary if you are one of the endangered species of lesser spotted English private buy-to-let investors.

The taxpayer hulked. Swore. Cursed the gods. Stubbed their toe, after lashing out at a nearby piece of furniture.

Their instinctive reaction was to wonder why they worked so hard, when the tax authorities claimed so much of the rewards?

A day’s wages taxed at 40%. Then taxed another 11% via National Insurance for good measure.

If they saved and invested, rather than squandered, their after-tax wages they face even more taxes.

Investment income generated outside of tax-advantaged accounts were taxed.

Capital gains realised outside those same tax-advantaged accounts were taxed some more.

Yet somebody following the default life script experienced nothing like those vampiric attentions of the tax authorities. Work a permanent job. Contribute to the workplace pension. After-tax savings first serving as a house deposit, combined with as much mortgage as a lender will lend them, to purchase as much owner-occupied property as they could possibly afford.

Any future savings thrown into overpaying the mortgage. “Earning” a tax-free return in terms of reduced interest payments. That return a couple of percentage points greater than parking the same funds in a savings account.

Climb the property ladder. More house. Better location. All free from capital gains tax.

Once the mortgage is paid off, or at least under control, diverting those savings into a private pension. Tax-free on the way in. 25% tax-free lump sum on the way out. The rest taxed at whatever post-retirement marginal tax rate happens to apply.

An objective observer may be forgiven for wondering why the taxpayer wouldn’t cash in their investments and pour the after-tax proceeds into a house? The same question had occurred more than once to the disorganised taxpayer.

Taxing

Tax can be an emotive topic just as much as a financial one. Pay it? Evade it? Avoid it?

Making a contribution to society, or having our pockets picked by an unscrupulous government?

Sometimes circumstance, lack of education, poor planning, or just “life happens” events result in unsheltered assets being held in taxable accounts.

Not all asset classes can be safely housed within tax-advantaged wrappers.

Residential property.

Cryptocurrencies.

Non-fungible tokens.

Art. Antiques. Collectables.

The taxpayer in our story scored some own goals, by failing to plan ahead to ensure they could meet the taxation obligations incurred as a result of their financial activities. A trap more than a few starry-eyed crypto investors potentially now find themselves facing when filing their self-assessment tax returns.

Particularly anyone foolish enough to use Bitcoin for its intended purpose, a form of currency, to actually pay for things! Where every single purchase potentially receives a complimentary capital gains tax bill.


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24 Comments

  1. The Bludger 7 November 2021

    So, what do you plan to do next year. Follow the wisdom of your dad, default lifescript or stay the course paying a ton of tax?

    • {in·deed·a·bly} 8 November 2021 — Post author

      Lol! Thanks Bludger.

      After running a business for 20+ years, I long ago learned the importance of cash flow projections and not spending the tax man’s money (even if payment wasn’t actually due for many months).

      In my investment career, I’ve strived to balance out investing for positive cash flow (to support current lifestyle) and investing for capital growth (to provide for future lifestyle). My father would not have approved!

      The taxpayer in the story was not me, though it was someone I’m close to, who should have known better. Alas the rude surprise experienced is an annual occurrence. Some people are forever stuck in a loop of claiming credit for their wins and blaming externalities for their losses, while never learning from their mistakes.

  2. David Andrews 8 November 2021

    Nice article and many points you raised have direct impact on my household. There are distinct points on the income scale where the benefits of any extra earnings greatly diminish.

    I class my employment earnings as fairly decent but they bring the problem of being in the range of losing child benefit unless I use the evil schemes to reduce my net adjusted income. I use salary sacrifice but that brings other potential issues “annual allowance and lifetime allowance limits”.

    My partner has “other issues” but I’ll concentrate on the financial ones. She is self employed and takes as little salary as possible. Her significant earnings are held by the company … of which she is a sole shareholder. Trying to extrcat any money from her or the company appears to require an extraordinary meeting.

    I smiled at the descriptions of the tax payers in your article. I greatly resemble your Father and my partner is very much like the second example, especially the agonised howls and last minute filings.

    Tax legislation can have a umber of unintended consequences. Public sector workers leaving due to generosity of some pension schemes and as my (ex) tenant found out, landlords selling up or taking back possession.

    Learn the rules, operate within them and keep your paperwork up to date.

    Hang on, do you mean I need to pay tax on the 1000000% gain on my Labradoodle coin holdings ???? Urgh – this is so unfair !!!!!!!!!!!!!!!!

    • {in·deed·a·bly} 8 November 2021 — Post author

      Thanks David.

      Your partner’s challenges of extracting money from her company sound familiar, something faced by many independent consultants and enveloped real estate owners. Eventually, the fortunate ones build up sufficient net worth to be willing to afford the sort of tax advice that makes using a Personal Investment Company a viable route.

      For mine, I say swing for the fences! Skip all the noise and intermediate steps, and go for a South Dakota flavoured dynastic trust.

      • David Andrews 8 November 2021

        I’d also strongly advise against telling your “friend” that a lot of the issues could have been avoided with a bit of forward planning and not submitting the tax return at the last minute.

        I speak from bitter experience on that matter. Families are complicated, as you know.

  3. Sas 8 November 2021

    I recommend Daylight robbery by Dominic Frisby, if you want to understand how pervasive tax is to our history. It is an enjoyable romp through the impact on our history of taxes and what might come next.

  4. GentlemansFamilyFinances 8 November 2021

    I’ve heard a lot of son stories about people facing totally foreseeable tax bills. I never have much sympathy for them – however the real trick is learning to play the system.
    Salary sacrifice is a great one or Pensions if you c as can’t (for a few years and then the LTA raises its ugly head).
    ISAs are obvious, LISAs maybe not as so.

    If you want to start hitting down, there’s a stark difference between those who are eligible for tax (payer funded) credits, housing benefits and all the rest and those who are entitled to nothing.

    No matter how much or little you have you will always feel a way to feel aggrieved if you want to.

    • {in·deed·a·bly} 8 November 2021 — Post author

      Thanks GFF.

      I agree that failing to plan ahead for a predictable tax bill is a school boy error deserving little sympathy. The trap around the tax-free threshold clawback, or the child tax credits which others have mentioned are things I think the taxpayers have a legitimate grievance about.

      • GentlemansFamilyFinances 8 November 2021

        Grievance is one thing but it won’t change things.
        Sadly, people seldom discuss the joys of tax in public, so people have to come to either the realisation via he internet or self assessment.

  5. John Smith 8 November 2021

    Yep, not for every-one, but your “South Dakota Trust” rules remind me why UK leaders have offshore-accounts. Ha ha, to pay their “fair” share of tax.

    It is not enough to learn the UK tax law. If UK is not your jail (as almost any country tries to be for its “subjects”) then UK tax-advantaged accounts will mean (next to) nothing in your next host country; which will demand its share-tax for your earnings (ISA/ SIPP) to which it had no past involvement.

    The next logical trick (after UK tax-shelter) is to split a big target (you) into small multiple targets (your family /trusts). Because any “decent” capitalist country has a PA (personal allowance) per person. Even better if you could spread into many out-of-UK accounts (family “gifts”).

  6. weenie 8 November 2021

    Thanks for reminding me that I need to sort out my taxes – it slipped my mind! The BTL side hasn’t been great for me this year, so bad that I think I’ll have zero tax to pay!

    • {in·deed·a·bly} 9 November 2021 — Post author

      Thanks Weenie. It has certainly been a taxing (boom boom!) year for private BTL let landlords.

      One well-located building where I own a flat currently has 8 out of 48 apartments up for sale. There aren’t any unfunded maintenance issues or changes in the local neighbourhood, rather the current tax rules have made it very challenging for private landlords to make the numbers work (a challenge that will get infinitely harder as interest rates rise).

      Combine that with the Brexit induced vacuum of potential tenants, where there was once a large population of young professional migrants seeking their fortunes in what was once one of the world’s great cities. Another challenge that is unlikely to go away anytime soon.

      • weenie 9 November 2021

        The owners of those apartments should consider themselves fortunate that they can put their properties up for sale – I’m unable to, due to the ongoing cladding issue, unless I was to sell to a cash buyer at a fraction of what I paid!

        • {in·deed·a·bly} 9 November 2021 — Post author

          Perhaps, though I’m not sure they would see it that way.

          Can’t sell due to an unresolved maintenance issue or can’t sell due to an absence of willing buyers.

          Can’t rent out due to an unresolved maintenance issue or can’t rent out due to an absence of willing tenants.

          The root cause may be different, but the outcome is the same.

          In both cases, private landlords are haemorrhaging money on empty properties with mortgages to pay. In both cases, the problem can only be resolved by a combination of flexibility on price and having deep pockets. In both cases the landlords were blindsided by an externality which was unlikely to have been on their radar when they purchased their properties.

          Possibly the only material difference is the government has established the Building Safety Fund to bail out (some) landlords facing the cladding issue. So providing you’re a “friend of the Tory party“, the cladding fairy may appear and make your problems go away.

          • weenie 11 November 2021

            Sadly, the Building Safety Bill may cover some as yet to be confirmed costs but won’t refund me the thousands I’ve already paid for ‘Waking Watch’ services

  7. steveark 13 November 2021

    It is just pretty simple to know what your passive income sources are going to make you in addition to a salaried job. Plus anyone who owes a ton of taxes from investments doing well has the rest of that investment income to pay the unexpected taxes. After all taxes are only a portion of the income, less than half by a long shot so there is no way you could ever earn your way into a tax problem because the earnings that got you there are mostly in your pocket and available to pay the taxes. Or am I missing something?

    • {in·deed·a·bly} 13 November 2021 — Post author

      Thanks Steverark.

      For the most part you are correct. Though in the UK currently, the basis for taxing private landlords is tied to revenue rather than profits, so some investors now find themselves paying taxes on loss making properties.

      The tax issue can be an emotive one, where some folks (including the taxpayer in this story) make financially irrational decisions.

  8. F Tt 13 November 2021

    The UK tax system can be counter productive. Using me as an example, former high earner (1k+ day rates) until put out of business by IR35 changes. Now quite determined to keep my taxable income at 50k max. More than that and I hit a 75% tax between 50-60 due to child benefit claw back. 4 kids.

    I could earn more, but with my current family circumstances, a stress free and working (unofficially) part time is a better use of my time than working to give more to HMRC.

    As a single income family, this govt have made it tough.

    • {in·deed·a·bly} 13 November 2021 — Post author

      Thanks F Tt. There’s definitely something not right when the government gets more of each additional pound earned than the person earning it.

  9. bsdb3 15 November 2021

    I made a similar mistake a few years back forgetting to make a lump-sum pension contribution before the end of the financial year and therefore failing to get the relief on the higher-rate tax I’d paid, coupled with claw back of child-benefit. It was on a much smaller scale to your example, but enough annoyanace/anguish I’ve not made the same mistake again! I suspect paying into a pension is not the panacea I see it as, but equally I couldn’t drive into work on a Saturday morning to do overtime, knowing the proportion that was being taken in tax.

    • {in·deed·a·bly} 16 November 2021 — Post author

      Ouch! That sounds like an expensive lesson bsdb3.

      It is a crazy system that legally allows to earn more than the worker does for extra work performed.

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