What is the difference between tax planning, tax avoidance, and tax evasion?

Tax planning is using legitimate reliefs and allowances as Parliament intended (e.g., ISAs, pension contributions, gift allowances). Tax avoidance is using legal structures in ways not intended by Parliament to reduce tax - HMRC may challenge these under the General Anti-Abuse Rule (GAAR). Tax evasion is illegal concealment of income or assets from HMRC. The line between planning and avoidance can be blurry, which is why professional advice matters.

How does the surplus income exemption work in practice?

You calculate your after-tax income, subtract your normal living expenditure, and gift the surplus. For example: GBP 150,000 net income minus GBP 100,000 living costs = GBP 50,000 surplus that can be gifted each year with zero IHT implications. You must keep records showing: (1) income received, (2) regular expenditure, (3) the gift pattern is regular, and (4) your standard of living is maintained. HMRC form IHT403 is used to claim this on death.

What is a Family Investment Company (FIC) and who should consider one?

A FIC is a private company where parents hold voting shares (control) and children hold growth shares (economic benefit). Investment returns accrue to the children's shares, removing future growth from the parents' estate. FICs are typically suitable for families with GBP 500,000+ in investable assets. Setup costs are GBP 5,000-15,000, with ongoing costs of GBP 2,000-5,000 per year for accounts and compliance.

Should I put my assets in a trust for IHT purposes?

Trusts can be effective for IHT but come with complexity. Transfers into most trusts are immediately chargeable at 20% if they exceed your available nil-rate band (GBP 325,000). Trusts also face a periodic charge of up to 6% every 10 years on the value above the NRB, plus exit charges when assets leave the trust. For many families, direct gifting or FICs may be simpler and more tax-efficient.

How can pension drawdown timing reduce my overall tax bill?

Strategic pension drawdown involves taking income from your pension at times when your marginal tax rate is lowest. Before April 2027, the incentive was to leave pensions untouched (zero IHT). After April 2027, pensions enter the estate, so drawing down during lower-income years and gifting the surplus income or investing in BPR-qualifying assets may produce a better overall outcome than leaving the pension intact.

What is the seven-year rule for gifts?

Gifts made more than seven years before death are fully exempt from IHT. Gifts made within seven years are subject to taper relief: 0-3 years = 40% (no relief), 3-4 years = 32%, 4-5 years = 24%, 5-6 years = 16%, 6-7 years = 8%. This only applies where the cumulative gifts exceed the nil-rate band. Small annual exemptions (GBP 3,000 per year) and gifts from surplus income are immediately exempt regardless of the seven-year rule.

Can I reduce IHT by downsizing my home?

Downsizing can reduce your estate value, but be cautious about the RNRB. If you sell your main residence and do not buy a replacement qualifying property, you may lose the GBP 175,000 RNRB. However, there is a "downsizing addition" that can preserve the RNRB if you downsize after 8 July 2015 and leave assets of equivalent value to direct descendants. Professional advice is essential here.

What tax reliefs are available for charitable giving?

Charitable giving reduces IHT in two ways. First, gifts to registered charities are exempt from IHT entirely. Second, if you leave 10% or more of your net estate to charity, the IHT rate on the remaining taxable estate drops from 40% to 36%. For large estates, this 4% reduction can mean the charity effectively costs less than the tax saved. Gift Aid on lifetime donations provides income tax relief at your marginal rate.

How do I protect against future tax rule changes?

Diversify your tax planning strategies. Do not rely solely on one relief (as those relying entirely on pension IHT exemption discovered in October 2024). Use a combination of: direct gifting (seven-year rule), surplus income exemption, BPR-qualifying investments, charitable giving, trusts where appropriate, and life insurance in trust. Review your strategy annually with a qualified professional, especially after each Budget.

What records do I need to keep for IHT planning?

Keep records of: all gifts made (date, amount, recipient, source of funds), surplus income calculations (annual income vs expenditure), trust documentation, BPR-qualifying investment purchase dates and valuations, pension nomination forms, life insurance trust deeds, and any professional advice received. Your executors will need these to complete the IHT return (form IHT400). Poor record-keeping is the most common reason valid reliefs are not claimed.

UK Tax Planning

Strategies, reliefs, and legal boundaries for UK estates over GBP 1M. From surplus income to Family Investment Companies.

Reviewed by [Reviewer Name], Chartered Accountant (CA)

Updated: February 202514 min read

TLDR

-Tax planning uses reliefs as Parliament intended. Tax avoidance exploits loopholes. Tax evasion is illegal. The line matters.
-The surplus income exemption is the most underused IHT relief: unlimited, immediate, and requires only good record-keeping.
-Family Investment Companies allow wealth transfer while retaining control. Typically suitable for GBP 500K+ investable assets.
-The seven-year rule for gifts offers full exemption, but taper relief applies for gifts within 3-7 years of death.
-Diversify your planning strategies. Relying on a single relief is risky - as the pension IHT change demonstrated.

Tax Planning vs Tax Avoidance vs Tax Evasion

Tax planning means using legitimate reliefs and allowances as they were designed to be used: ISAs, pension contributions, gift allowances, charitable donations, and Business Property Relief. This is both legal and encouraged by Parliament.

Tax avoidance uses legal structures in ways not intended by Parliament to reduce tax. HMRC can challenge avoidance schemes under the General Anti-Abuse Rule (GAAR), introduced in 2013. Schemes that are "abusive" - meaning they involve arrangements that no reasonable person would consider as a reasonable course of action - can be struck down.

Tax evasion is the illegal concealment of income or assets from HMRC. It is a criminal offence carrying penalties of up to 200% of the tax owed plus imprisonment. Everything discussed on this page falls firmly within legitimate tax planning.

The Surplus Income Exemption

The normal expenditure out of income exemption (often called the surplus income exemption) is one of the most powerful and underused IHT reliefs. It allows you to make gifts from your after-tax income with no IHT implications whatsoever - and there is no upper limit.

The three conditions are: (1) the gifts form a regular pattern, (2) they are made from income rather than capital, and (3) they do not reduce your standard of living. For someone with GBP 200,000 net income and GBP 120,000 annual expenditure, that is GBP 80,000 per year that can be gifted - GBP 800,000 over ten years - completely free of IHT. No seven-year wait required.

The key requirement is record-keeping. HMRC form IHT403 must be completed on death, showing income, expenditure, and the gift pattern. Executors who cannot evidence the exemption may lose it entirely.

Tax planning strategies compared
Strategy	IHT Saving	Time to Effect	Complexity	Control Retained
Surplus income gifts	Unlimited	Immediate	Low (records needed)	None
Seven-year gifts	Unlimited	7 years	Low	None
Family Investment Company	Growth only	Ongoing	High	Full voting control
Discretionary trust	Up to NRB	Immediate (with charges)	High	As trustee
BPR investments	50-100% of value	2+ years holding	Medium	Full ownership
Charitable giving 10%+	4% rate reduction	Immediate	Low	N/A
Pension drawdown + gifting	Variable	Before April 2027	Medium	Reduces pension
Life insurance in trust	Covers liability	Immediate on death	Low	Premium payments

Family Investment Companies

A Family Investment Company (FIC) is a private limited company used to hold and manage family wealth. The typical structure has parents holding voting and preference shares (providing control and income) while children hold ordinary growth shares (receiving economic benefit as the company value increases).

The IHT advantage is that future growth accrues to the children's shares, not the parents' estate. The parents retain full voting control over investment decisions, dividends, and company direction. This is one of the few structures that allows wealth transfer while retaining operational control.

FICs are typically suitable for families with GBP 500,000+ in investable assets. Setup costs range from GBP 5,000-15,000 with ongoing compliance costs of GBP 2,000-5,000 per year. Corporation tax applies to investment income within the company (25% on profits above GBP 250,000).

Gifting Strategies

Direct gifting remains the simplest IHT reduction strategy. Beyond the surplus income exemption, the annual gift allowance is GBP 3,000 per tax year (which can be carried forward one year), small gifts of up to GBP 250 per recipient, and wedding gifts (up to GBP 5,000 from a parent, GBP 2,500 from a grandparent, GBP 1,000 from anyone else).

Larger gifts fall under the seven-year rule: they are potentially exempt transfers (PETs) that become fully exempt if you survive seven years. Taper relief reduces the IHT charge for gifts made between three and seven years before death. The critical point is that taper relief only reduces the tax rate, not the taxable value - it only applies where cumulative PETs exceed the nil-rate band.

The right combination of tax planning strategies depends on your specific estate composition, income, family structure, and objectives. A qualified tax adviser can model different scenarios and identify the optimal approach.

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Important Notice

This content is for informational purposes only and does not constitute financial advice. Tax treatment depends on individual circumstances and may change. Consult a qualified professional before making financial decisions. MoneyBlis is not regulated by the Financial Conduct Authority and does not provide personalised financial advice.