How to Legally Reduce Your Tax Bill

There is a big difference between tax avoidance (legal) and tax evasion (illegal). Tax avoidance means using the reliefs, allowances and structures that Parliament has specifically legislated for. Tax evasion means hiding income or fabricating expenses. One is smart business planning; the other is a criminal offence.

This guide covers legitimate strategies that most UK small business owners can use to reduce what they pay.

Use your personal allowance

Everyone in the UK gets a personal allowance of £12,570 (2024/25). Your first £12,570 of income is tax-free. If you are a company director, make sure your salary is set to use this allowance before taking dividends.

If your total income exceeds £100,000, you start losing your personal allowance at a rate of £1 for every £2 of income above this threshold. Between £100,000 and £125,140, your effective marginal tax rate is 60%. Reducing your taxable income below £100,000 (through pension contributions, for example) can save you significantly.

Optimise your salary-dividend split

If you run a limited company , the way you extract profit makes a real difference.

The standard approach (2024/25)

Compare this with taking the same amount as salary:

• Salary above the personal allowance attracts 20-45% Income Tax plus 8% employee NIC plus 13.8% employer NIC
• Dividends attract 8.75-39.35% with no NIC at all

The saving from using dividends instead of salary at the basic rate is roughly £3,000-£5,000 per year. At higher income levels, the saving increases.

Make pension contributions

Pension contributions are one of the most tax-efficient tools available:

Employer contributions (through your company)

• Fully deductible against Corporation Tax
• No Income Tax or NIC for you
• Annual allowance of £60,000 (with carry-forward of unused allowance from the previous 3 years)

Personal contributions (as a sole trader)

• Deducted from your taxable income
• Basic rate relief applied automatically by the pension provider
• Higher rate relief claimed through Self Assessment

For a higher rate taxpayer, a £10,000 pension contribution effectively costs £6,000 after tax relief. The trade-off is that the money is locked away until age 55 (rising to 57 from 2028).

Claim all your allowable expenses

Many business owners under-claim expenses because they forget, lose receipts or do not realise something is deductible. Common expenses people miss:

• Home office costs – either HMRC’s flat rate (£10-£26/month) or actual proportion of household bills
• Professional subscriptions – trade bodies, industry associations
• Training and CPD – courses related to your current work
• Business insurance – professional indemnity, public liability
• Bank charges on your business account
• Bad debts – invoices you genuinely cannot collect
• Accountancy fees – fully deductible

See our expense tracking guide for a full list of allowable categories.

Use the Annual Investment Allowance

The Annual Investment Allowance (AIA) lets you deduct the full cost of qualifying plant and machinery from your taxable profits, up to £1,000,000 per year. This includes:

• Computers and IT equipment
• Office furniture
• Tools and equipment
• Commercial vehicles (not cars)
• Machinery

If you are planning a significant purchase, timing it within the right accounting period maximises the immediate tax benefit.

Claim R&D tax credits

If your business develops new products, processes or services that involve a technological advance, you may qualify for R&D tax credits. Many small businesses overlook this because they assume it only applies to laboratories and tech companies. In reality, any business solving a technical problem that a competent professional in the field could not easily solve may qualify.

For startups and SMEs, the merged R&D scheme provides above-the-line credits that directly reduce your tax bill or provide a cash payment if you are loss-making.

Choose the right VAT scheme

If you are VAT-registered , the scheme you use affects how much VAT you actually pay:

The Flat Rate Scheme can be particularly beneficial for service businesses that charge 20% VAT but have few VATable purchases. You keep the difference between the 20% you charge and the flat rate percentage you pay (which varies by sector, typically 12-16.5%).

Use your spouse or partner

If your spouse or civil partner is a lower-rate taxpayer (or has unused personal allowance), there are legitimate ways to share income:

For limited companies

If your spouse is a shareholder and genuinely involved in the business (even in an administrative capacity), they can receive dividends. This spreads income across two personal allowances and two basic rate bands.

HMRC will challenge this under the settlements legislation (Arctic Systems case) if the arrangement has no commercial substance, but the courts have generally upheld spouse dividends where the spouse is a shareholder and performs some function.

For sole traders

You cannot simply redirect self-employment income to a spouse. However, if your spouse genuinely works in the business, you can pay them a reasonable salary, which is deductible from your profits. The salary must reflect the work actually performed.

Carry back losses

If your business makes a trading loss, you can carry it back against profits from the previous year (or three years in certain circumstances). This generates a tax refund for the earlier year.

For a new business that makes a loss in its first year, this can result in a Corporation Tax refund for the previous year’s profits, providing a useful cash injection.

Make charitable donations

Limited companies can deduct qualifying charitable donations from their taxable profits. This reduces Corporation Tax on the donated amount.

For personal donations made through Gift Aid, the charity reclaims 25p for every £1 you give, and if you are a higher rate taxpayer, you can claim additional relief through Self Assessment.

Time your income and expenses

If you have any control over when you recognise income or incur expenses, you can sometimes manage your tax position:

• Delay invoicing a late-year project into the next accounting period (if commercially reasonable)
• Bring forward expenses – prepay annual subscriptions, buy equipment before year end
• Accelerate pension contributions into a year where your marginal rate is higher

This is legitimate tax planning. The key is that the timing must reflect genuine commercial decisions, not artificial manipulation.

Use ISAs for personal savings

While not a business tax strategy, using your ISA allowance (£20,000 per year) ensures that investment returns from your personal savings are completely tax-free. This is relevant for business owners accumulating savings from dividend income.

Get professional advice

The strategies that save the most money are often the ones that require professional advice to implement correctly – pension planning, R&D claims, restructuring, using making tax digital effectively. An accountant who understands your business can identify reliefs you would otherwise miss.

The cost of good tax advice is almost always less than the tax it saves you.