Tax Favoured Investments: Your options explained
Kirsty Foster · January 11th 2023 · read
Utilise individual savings accounts
Individual savings accounts (ISAs) may be an excellent investment for higher-rate taxpayers to consider. The maximum allowance is £20,000. You must save or invest by 5 April for it to count for that year and if you don’t use the allowance it is lost.
The ISA family has grown considerably since its inauguration in 1999. We set out below further ISAs for consideration.
Help to buy ISA
First-time buyers get a 25% cash bonus from the Government on savings made into a help to buy ISA. The help to buy ISA closed to new accounts on 1 December 2019.
If you had already opened a help to buy ISA, you will be able to continue saving into your account until November 2029.
UK residents aged between 18-39 can contribute up to £4,000 per tax year towards their first home or retirement and the Government will then add a 25% bonus at the end of each tax year in respect of the contributions paid.
Innovative finance ISA
This lets you put your savings with peer-to-peer lenders or invest in companies through crowdfunding websites.
Consider investing in Enterprise Investment Scheme and Seed EIS Shares
Tax relief is available where you subscribe for shares qualifying for relief under the Enterprise Investment Scheme (EIS) or Seed EIS (SEIS).
Under the EIS, your Income Tax liability for the tax year in which you make your investment, or the previous tax year, may be reduced by up to 30% of the sum invested. You can invest up to £1m under the EIS in a tax year or up to £2m if you invest in knowledge-intensive companies (broadly these are early-stage businesses engaged in scientific or technological innovation).
If you sell your EIS shares at a profit after three years and the Income Tax relief claimed when they were acquired is not withdrawn, there is a Capital Gains Tax (CGT) exemption on the disposal of the EIS shares.
Losses on EIS shares (restricted by Income Tax relief given and not withdrawn) can be offset against gains or, alternatively, against general income in the tax year of disposal or the preceding year.
Inheritance Tax relief (via Business Property Relief) should be available for EIS shares provided they are held for two years.
In addition, capital gains arising on disposals of other assets may be deferred by reinvesting those gains in a subscription for qualifying EIS shares. The investment in EIS shares must be made in the period beginning one year before and ending three years after the disposal.
The Seed EIS offers relief for investors who subscribe for shares in small start-up companies. Currently, the maximum qualifying investment is £100,000 per tax year (£200,000 from 6 April 2023). Income tax relief is given at the rate of 50% of the sum invested, and relief may be given against tax in the tax year the investment is made or the prior tax year.
SEIS shares are exempt from CGT if they are held for three years and the Income Tax relief claimed when they were acquired is not withdrawn.
They can also benefit from Inheritance Tax relief if held for two years. A loss on disposal of SEIS shares can be set against other gains.
If you dispose of another asset at a gain and re-invest all or part of that gain in shares which qualify for SEIS relief, half of the gain re-invested may be exempted from CGT.
A number of professionally managed EIS and SEIS investment funds exist, which invest in a broad range of EIS and SEIS companies on behalf of investors. Whilst such funds should allow for risk management through the spreading of your investment between different companies, it must be remembered that EIS and SEIS investments will, more likely than not, be viewed as carrying with them a high degree of risk.
Prudent utilisation of the reliefs associated with tax-favoured investments as part of a balanced portfolio can make a big difference to future investment returns, but it is important to consider the risks associated with them and it is essential that professional advice is sought.
Venture Capital Trusts
Venture Capital Trusts (VCT) are specialist tax-incentivised investments that enable individuals to invest indirectly in a range of small higher-risk trading companies and securities. VCTs are companies in their own right and, like investment trusts, their shares trade on the London Stock Exchange.
Shares in qualifying VCTs offer the following tax incentives:
- Upfront income tax relief at 30% of the amount subscribed, subject to a maximum investment of £200,000 per tax year. The investment must be held for a minimum of five years in order to retain the income tax relief. Note that income tax relief on the purchase of VCTs is available only where new shares are subscribed, and not for shares acquired from another shareholder.
- Dividends received on VCT shares are exempt from income tax in respect of shares acquired within the ‘permitted maximum’ (including shares acquired from another holder).
- CGT exemption applies to the VCT shares (including shares acquired from another holder).
Family Investment Companies (FICs)
FICs can be a useful way to protect family wealth. The most appropriate structure will depend on the family’s circumstances and objectives.
An FIC enables parents and grandparents to retain control over assets whilst protecting and enhancing wealth in a tax-efficient manner, as well as facilitating future succession planning.
By subscribing for shares in the company and appropriately funding it the directors can use the structure to invest tax efficiently and for future growth.
Where the company makes profits and gains these will be subject to corporation tax. It should be noted that corporation tax is rising from 19% to 25% in April 2023, where company profits exceed £250,000. A lower rate of 19% will continue to apply where company profits are not more than £50,000.
Even with the upcoming corporation tax rate rise, in most cases, this will still be lower than if the investments had been held directly or via trust, and suffered income tax at 40%/45%, and capital gains tax at a maximum of 28%.
If the company receives UK dividend income from investments in shares, it will be exempt from tax. However, interest (from saving accounts), rents (from investment properties) and other income will be taxable. Losses from rental income can be offset against other income in the company.
An FIC should be considered for long-term asset protection planning, as well as for planning for the income needs of the family. Shareholders only pay tax personally when the FIC distributes income, or if it is wound up. There is merit in using an FIC to allow profits to be retained in the company until required, when the individual’s personal tax rate may be lower.
Any investment gains and income could be paid into a pension plan for the benefit of the shareholders, therefore it is recommended that parties to an FIC receive independent financial advice.
If you are seeking to preserve family wealth within a controlled family environment and/or wish to consider introducing the next generation into the decision-making about investments, please speak to your professional adviser about how an FIC could benefit you.
This article should not be construed as advice or a personalised recommendation. The most suitable solution for you will depend on your own personal circumstances.
No action should be taken without seeking further formal advice.
MHA Moore and Smalley is regulated by the Financial Conduct Authority. Our FCA registration number is 448716.