Tax Efficient Investments
Tax Efficient Investments
Claiming back income tax is a rare thing, but not for tax efficient investments!
The Basics
There are various, HMRC approved, investment wrappers that offer people who invest in them generous tax reliefs. These are all designed to help reduce the risk of investors investing in unlisted start-up and expanding companies while providing investment for private companies that require it.
The unique things about these reliefs are that that offer tax relief against ‘income tax’ as well as capital gains tax. This is a genuinely unique feature as the only other income tax relief wrapper is a pension where the funds are tied up until age 55.
Once HMRC has approved a company as a qualifying company, investors purchase shares in the business, and the cost of the investment dictates the amount of tax relief that can be claimed.
For example, if you invest in a qualifying EIS company of £50,000, you could claim back £15,000 from your income tax either paid or payable in that year. (note you can’t claim back more than you have paid in any tax year)
You can also defer any capital gains tax paid in either the year the investment was made or three tax years prior.
For example, after investing the previous example, you also had made a capital gain of £20,000 in the same tax year you could reinvest the £20,000 into the new investment and defer paying the capital gains tax due until the new investment is sold in the future.
There are three main types of tax-efficient investment:
1. Seed Enterprise Investment Scheme (SEIS)
- 50% income tax relief
- Capital gains tax relief
- No capital gains on share sale
- Loss relief if the investment fails
2. Enterprise Investment Scheme (EIS)
- 30% income tax relief
- Capital gains tax relief
- No capital gains on share sale
- Loss relief if the investment fails
3. Venture Capital Trust (VCT)
- 30% income tax relief
- Capital gains tax relief
- No capital gains on share sale
There is a place in a portfolio for all of these types of tax-efficient investment. However, the balance needs to be managed carefully as most of these types of investment are illiquid.
We have access to some of the UK’s leading providers and can advise you on the types of tax-efficient investment that might best suit your needs.
Seed Enterprise Investment Scheme - SEIS
- Introduced in 2012 by HMRC
- 50% Income Tax Relief
- Capital Gains Tax Relief
- Loss relief at highest marginal rate
- Tax-free investment growth
- Inheritance tax-free after two years
The Seed Enterprise Investment Scheme was introduced in 1997 by HMRC. Its aim is to encourage private investors to invest in start-up companies in the UK to provide the essential seed capital needed to get a business off the ground.
Due to the inherent risk involved in investing in this type of company, HMRC offers investors a 50% tax relief against income tax on the value of the investment they make – essentially sharing the risk with the investor.
If the company were to fail and the invested funds lost there is further loss relief from future income tax available on the net investment at the investors highest marginal rate.
The aim is for the company to grow and either purchase back the shares from investors in the future at a premium, or the company may be sold and a capital gain made. Under SEIS rules all investment returns are tax-free when treated as a capital gain. However, any dividends paid will be treated as income in the usual way and taxed accordingly.
As the company must be unlisted (not including AIM) the shares the investor owns should qualify for business property allowance (BPR) after two years. This means they can be left inheritance tax free to a beneficiary and will not form part of the taxable estate in the event of death.
This unique type of investment not only offers the highest income tax relief in the UK when you make an investment, but also offers tax-free investment growth when the investment is sold in the future. This makes it one of the only UK investments to offer tax relief at both ends of the investment process.
| SEIS Example | Amount |
|---|---|
| Investment | £20,000 |
| Tax Relief | £10,000 |
| Net Investment | £10,000 |
| Loss Relief | £4,000 |
| Total Risk Capital | £6,000 |
Enterprise Investment Scheme - EIS
- Introduced in 2012 by HMRC
- 30% Income Tax Relief
- Capital Gains Tax Relief
- Loss relief at highest marginal rate
- Tax-free investment growth
- Inheritance tax-free after two years
The Enterprise Investment Scheme was introduced in 1997 by HMRC. Its aim is to encourage private investors to invest in expanding companies in the UK, to provide the capital needed for them to grow.
Due to the inherent risk involved in investing in this type of company. HMRC offer investors a 30% tax relief against income tax on the value of the investment they make, helping to reduce the risk to the investor.
If the company were to fail and the invested funds lost there is further loss relief from future income tax available on the net investment at the investors highest marginal rate.
As well as 30% income tax relief, it is also possible to defer any capital gains made in the three years previous to the investment. If you have made a capital gain one of those years you can opt to re-invest the gain into an Enterprise Investment Scheme qualifying company and defer the payment of the capital gain until the investment is sold in the future.
The aim is for the company to grow and either purchase back the shares from investors in the future at a premium, or the company may be sold and a capital gain made. Under Enterprise Investment Scheme rules all investment returns are tax-free when treated as capital gains. However, any dividends paid will be treated as income in the usual way and taxed accordingly.
As the company must be un-listed (not including AIM) the shares the investor owns should qualify for business property allowance (BPR) after two years. This means they can be left inheritance tax free to a beneficiary and will not form part of the taxable estate in the event of death.
This unique type of investment not only offers the highest income tax relief in the UK when you make an investment but also offers tax-free investment growth when the investment is sold in the future. This makes it one of the only UK investments to offer tax relief at both ends of the investment process.
| EIS Example | Amount |
|---|---|
| Investment | £20,000 |
| Tax Relief | £6,000 |
| Net Investment | £14,000 |
| Loss Relief | £5,600 |
| Total Risk Capital | £8,400 |
Venture Capital Trust - VCT
- Introduced in 2012 by HMRC
- 30% Income Tax Relief
- Tax-free dividend income
- Tax-free investment growth
A venture capital trust or VCT is a tax-efficient UK closed-end collective investment scheme. It is designed to provide private equity capital for small expanding companies and capital gains for investors.
It is similar to an EIS however VCT’s are operated by a fund manager who will select circa 20 companies to invest in on behalf of investors.
To encourage investors, the government offers 30% income tax relief on the value of the investment, however the investment. However the investment needs to be held for a minimum of 5 years for the relief to remain qualifying.
Aside from the upfront tax-relief, the other key advantage of a VCT is that any dividends paid are tax-free to the investor. This can create a useful additional tax free income while also allowing the investor to claim tax relief at the time the investment was made.
As well as tax-free dividends there is no capital gains tax to pay on any investment growth the VCT makes.
Unlike SEIS and EIS’s there is no loss relief available if the fund fails and there is no way to defer or relieve capital gains tax in the same investment,
Typically speaking most VCT’s aim to create an income return of 5% and above each year, which due to the tax-free classification is the equivalent to a 7% real return to a high rate taxpayer.
These types of investment should be approached with a long term view due to the five-year relevant period.
It is important to note that a VCT does not qualify for Business Property Relief (BPR) and therefore will form part of the investor’s estate upon death.
| VCT Example | Amount |
|---|---|
| Investment | £20,000 |
| Tax Relief | £6,000 |
| Net Investment | £14,000 |
| Total Risk Capital | £14,000 |
