The Chancellor of the Exchequer recently decided to focus his attention on restricting tax reliefs for higher income earners. At the core of these budgetary changes is draft legislation to reduce unlimited income tax reliefs by setting a cap of £50,000 or 25% of income, whichever is higher per tax year for individual investors.
Obviously public reaction has been negative particularly as charitable donations were previously included in the draft proposals. In an attempt to pacify voters and party donors, George Osborne reneged and has excluded charitable donations from these changes. Most of the legislative changes have been incorporated into the Financial Bill 2012 which is expected to receive Royal Assent during summer 2012.
To refresh this article provides an overview of the principal investment vehicles that receive tax relief concessions. These investment vehicles are not to be confused with ‘morally repugnant’ tax avoidance schemes.
Individual Savings Accounts (ISAs)
ISAs were introduced on 6 April 1999 by the then current Chancellor of the Exchequer Gordon Brown. ISAs were intended to provide a tax efficient savings vehicle for all types of investors allowing access to both cash savings and stock market linked products.
The maximum contribution limit now stands at £11,280 for Stocks & Shares or up to £5,640 that can be invested in a Cash ISA this tax year per individual investor.
There is no tax to pay on income and capital gains however the 10% tax credit on UK Dividends cannot be reclaimed.
Investors can access ISA funds at any time free of Income Tax and Capital Gains Tax.
Personal Pensions
Personal Pensions were formally introduced on 1 July 1988 to promote access for investors who could not join an occupational pension scheme.
Policyholders can claim income tax relief on contributions up to £3,600 (without evidence of earnings) or 100% of relevant earnings up to a maximum of £50,000 per tax year (both employee and employer combined) at the marginal tax rate. You can increase contributions above this maximum by utilising carry forward of unused allowances from previous 3 years. Once invested there is no tax to pay on income and capital gains however the 10% tax credit on UK Dividends cannot be reclaimed.
In an attempt to limit the tax concessions available from pensions, HMRC applies a lifetime allowance test on certain events. The lifetime allowance limits was reduced to £1.5m from 5 April 2012
The earliest an investor can access the pension is age 55. You have the option to take up to 25% of the accumulated fund as a tax free lump sum (Pension Commencement Lump Sum) and the residual fund may purchase an income stream or you may remain invested until such time income is needed. There is no longer the compulsion to take an annuity by age 75.
Venture Capital Trusts (VCTs)
VCTs schemes commenced from 6 April 1995 and were introduced to encourage individuals to invest in small high risk Companies (Gross assets before subscription < £15m).
VCTs employ a professional fund manager to pool the monies and invest into a range of Companies that require capital for start up or expansion. Investors receive shares in a Company.
To incentivise capital inflows from investors, the HMRC allows certain tax concessions. You can now invest up to £1m each tax year into the investment Company. Income tax relief of 30% is available at the launch of new VCT shares or when a VCT raises new money (income tax relief cannot exceed your income tax liability).
There is no tax to pay on dividend income (however the 10% tax credit cannot be reclaimed) and nil tax on capital gains if held for at least 5 years. If you sell or otherwise dispose of the VCT shares within 5 years; relief is withdrawn and an income tax charge will apply.
VCTs are high risk investments and there may be no market for the shares should investor wish to dispose of them. An investor could lose their capital.
Enterprise Investment Schemes (EIS)
Similar to VCTs, EIS were introduced to encourage individuals to invest in small unlisted Companies (Gross assets before subscription < £15m). EIS employ a professional fund manager to pool the monies and invest into a range of Companies that require capital for start up or expansion.
Investors receive Shares in a Company.
You can now invest up to £1m each tax year into qualifying shares in EIS. Income tax relief of 30% is available on the investment amount is available at the launch of newly issued shares. There is no tax to pay on capital gains if held for at least 3 years. If you sell or otherwise dispose of the EIS shares within 3 years; relief is withdrawn and an income tax charge will apply.
You may also defer capital gains on other assets until such time you sell the EIS shares.
If the shares are disposed of at a loss, you can elect that the amount of the loss, (less Income Tax relief given) can be set against income of the year in which they were disposed of, or any income of the previous year, instead of being set off against any capital gains.
EIS are also eligible for Business Property relief and are therefore inheritance tax free if held for at least 2 years.
SEED Enterprise Investment Schemes (SEIS)
SEISs were announced in the 2011 Budget and form part of the Finance Bill 2012 as a tax advantaged venture capital scheme for higher risk start-up Companies. Investors receive Shares in a Company.
Individual investors can claim up to 50% income tax relief up to a maximum annual investment of £100,000. The increased tax relief (compared to EIS) is offered due to the increased risks as the qualifying Companies are smaller (assets less than £200,000 and have been trading for a less than two years).
There is no tax to pay on gains if held for at least 3 years. If you sell or otherwise dispose of the SEIS shares within 3 years; relief is withdrawn and an income tax charge will apply.
Capital Gains reinvestment relief is also available if you reinvest part or all of chargeable gains in a tax year into SEIS although this still forms part of the maximum £100,000 annual contribution limit.
SEIS are also eligible for Business Property relief and are therefore inheritance tax free if held for at least 2 years.
Enterprise Investment Schemes (EISs) and Seed Enterprise Investment Schemes (SEIS) are very high-risk investments. An EIS/SEIS investment is usually concentrated in one single unquoted trading company. Often there is no market for the shares and it may therefore be very difficult to make a disposal. There is a strong possibility of the chosen company failing.