A Guide To: Tax Efficient Investments
W1 Investment Group specialise in arranging UK Government approved tax efficient investments. These can help to reduce and in some cases eliminate Income Tax, Capital Gains Tax and Inheritance Tax.
We have access to EIS and VCT opportunities on a whole of market basis – and we offer innovative technology to allow investors to view their tax efficient investments online.
Our advisers can explain the tax benefits and risks involved and help you decide whether or not EIS and VCT investments are suitable for you.
Important: EIS and VCT investment are high risk and only recommended for sophisticated investors. The information provided here must only be considered as a guide and not as advice. Please contact us for specific advice on your own individual situation.
We particularly draw your attention to the risks of these kinds of investments. Please ensure that you read ‘What Are The Risks?’ at the end of this guide.
The Enterprise Investment Scheme
What is the Enterprise Investment Scheme? (EIS)
The Enterprise Investment Scheme, or EIS, was introduced by the UK Government to give tax incentives to individuals wishing to invest in high risk small businesses. By offering considerable tax breaks, the scheme aims to both make funding such businesses more attractive to investors and to inject much needed capital into the sector. EIS investments can be used to reduce or even eliminate Income Tax, Capital Gains Tax and Inheritance Tax. Investors can invest either directly into EIS shares or into an EIS fund containing a ‘basket’ of EIS shares.
Using EIS Investments to Reduce Income Tax
Investors in EIS investments can claim back 30% of the invested amount against Income Tax due either in the year of investment or in the previous tax year. They can claim back up to £300,000 in any one tax year from a £1m investment into an EIS. The EIS Investments must be held for three years to maintain the tax relief.
Example: Let’s say you paid £45,000 in Income Tax in both the current and the previous tax year, or £90,000 total. You could invest up to £300,000 into an EIS and reclaim up to £90,000 against your current and past year’s Income Tax bill.
This can either be refunded directly by HMRC or offset against future tax due by amending your tax code. Any profits from the sale of EIS investments are exempt from Capital Gains Tax (CGT) as long as they have been held for three years.
Using EIS Investments to Reduce Capital Gains Tax
Investors can defer CGT from the sale of other assets by investing an amount up to the value of the gain into an EIS. They can defer gains that occurred up to three years before, or one year after, the investment into the EIS was made. When the EIS is sold CGT becomes payable on any gain at the rates prevailing at that time. However, investors can use their new CGT allowance and pay the remaining CGT or roll the investment over into another EIS investment.
Example: Let’s say you have a buy to let property which you sell to produce a gain of £100,000. You use your CGT allowance of £11,300, meaning your taxable gain is £88,700.
Instead of paying CGT, you decide to invest £88,700 into an EIS. As a result no CGT will be payable until the EIS shares are sold. At this point you can use your new CGT allowance to reduce the gain and invest the remainder into another EIS. This procedure can be carried out indefinitely.
Using EIS Investments to Reduce Inheritance Tax
EIS shares normally qualify for Business Relief. As a result they fall outside of the scope of your estate as long as they are held for more than two years and are still held when you die.
Example: Let’s say you buy £200,000 of EIS investments and die 10 years later. Your beneficiaries will receive the full value of your EIS shares without being liable for 40% Inheritance Tax.
How Loss Relief Operates
EIS investments are considered to be high risk and the returns of the individual companies may vary. Shares in some companies may rise in value, while others may fall. However, loss relief reduces the impact of any losses made on EIS companies. Loss relief can be claimed in the year or following year of when the loss is realised and can be used to offset any Income Tax or Capital Gains Tax payable. The loss is calculated against an effective starting price, ie. after Income Tax relief.
Example: Let’s say you buy EIS investments for £45,000 and claim Income Tax relief of £15,000. The effective cost of the EIS is therefore £30,000. Five years later the EIS is valued at £10,000 and so you have an effective loss of £20,000.
The loss relief you can claim depends on your marginal rate of Income Tax. So if you are a 45% tax payer it would be 45% x £20,000 = £9,000. You can then claim this back against Income Tax paid either in the current or following tax year. So, after Income Tax relief and loss relief, the most a 45% tax payer can lose in an EIS investment is 55%. The most a 40% tax payer can lose is 60%.
Venture Capital Trusts
What Are Venture Capital Trusts? (VCT)
Venture Capital Trusts, or VCTs, are collective funds which are listed on the London Stock Exchange. They invest in both unlisted or AIM listed small companies. The UK Government offers investors in VCTs valuable tax breaks in return for taking a higher level of risk. VCTs can be used to reduce an existing Income Tax bill. However they cannot be used to reduce Capital Gains Tax or Inheritance Tax. Both the gains and the dividends from VCTs are tax free.
Using a VCT to Reduce Income Tax
Investors in VCTs can claim back 30% of the invested amount against the current year’s Income Tax due. They can claim back up to £60,000 in any one tax year, as a result of investing up to £200,000 into a VCT. The VCT must be held for five years to maintain the tax relief.
Example: Let’s say you will pay £45,000 in Income Tax in the current tax year. You could invest up to £150,000 into a VCT, allowing you to reclaim up to £45,000 against your Income Tax bill.
This will either be refunded directly by HMRC or offset against future Income Tax by amending your tax code.
What Are The Risks
These are some of the risks of EIS and VCT investments which you should be aware of:
- Investment risk: The risk that the companies invested in may fail, reducing the value of your EIS or VCT to zero.
- Liquidity: EIS and VCT investments can be illiquid so they can be difficult to sell should you need access to your cash.
- Loss of tax relief: If you sell your EIS and VCT investments within their minimum holding period the tax relief will be withdrawn. Also bear in mind that tax rules and regulations may change.