Tax Efficient Investment Advice

Tax Efficient Investment Advice

by Ashley Clark, Director - March 2010

Using tax efficient investments

With the rates of tax effectively increasing, it is most important that people invest in the most tax efficient way possible.

(a) ISAs

The ISA is still the main method of investing savings with freedom from income tax and capital gains tax. There are still two types of ISA – a cash ISA and a stocks and shares ISA. The overall annual contribution limit is £7,200 of which no more than £3,600 can go into cash. The balance can be invested in a stocks and shares ISA. This means a couple could invest £14,400 between them. Those investors aged over 50 in this tax year can currently invest up to £10,200 into an ISA - £5,100 of which can be in a cash ISA. For somebody over age 50 who has not yet used all of their increased ISA allowance of £10,200, now could be the time to do this. From 6 April 2010, the increased ISA investment limit applies to all qualifying individuals irrespective of age.

(b) Other tax efficient investments

· Growth-orientated unit trusts/OEICs

Given the relatively high rates of income tax as compared to the current rate of capital gains tax (CGT), it makes tax sense to invest for capital growth as opposed to income. Whilst we mustn’t forget that CGT rates may well increase in the future - especially after the forthcoming General Election - based on the current rules growth-orientated unit trusts/OEICs (and zero dividend preference shares) look tax attractive for the higher rate taxpayer.

Although income (dividends and interest) on collectives is taxable - even if accumulated - if this can be limited so can any tax charge on the investment. Instead, if emphasis is put on investing for capital growth, not only will there be no tax on gains accrued or realised by the fund managers, it should also be possible to make use of the investor’s annual CGT exemption (currently £10,100) on later encashment with excess gains only suffering tax at 18% currently. For couples, it makes sense for them both to invest in order to be able to use both annual CGT exemptions when investments are encashed.

· Single premium investment bonds

Because single premium investment bonds are non-income producing, no taxable income arises for the investor during the “accumulation period”. Not only that, any dividend income accumulates without corporation tax within a UK insurance company’s internal investment funds. However, bonds are not so tax efficient from a CGT standpoint with capital gains (after indexation allowance) realised by the UK life fund suffering corporation tax of up to 20% . The investor policyholder will receive a basic rate tax credit for deemed taxation in the fund meaning that, on eventual encashment, a tax charge will only arise if the investor (after top-slicing relief) is then a higher rate or additional rate taxpayer.

Ways in which this tax charge may be mitigated involve the following strategies:-

(i) defer encashment of the bond until a year in which the investor is a basic rate taxpayer – say after retirement. In the meantime, if cash is required use the 5% tax-deferred withdrawal facility

(ii) assign the bond to an adult basic rate or non-taxpaying relative (say spouse or children) pre encashment; the assignment will not trigger a tax charge and tax should be avoided on subsequent encashment.

Of course, more tax efficiency at fund level can be achieved via an offshore bond because there is no internal tax charge on investment growth. However, there is then no tax credit for a UK resident investor. Whether a UK or offshore bond is best for any particular investor will depend on the facts. Advice is essential.

(c) Enterprise Investment Scheme (EIS)

The EIS offers tax relief on an investment in new shares of an unquoted trading company which satisfies certain conditions. For tax year 2009/10 an investment of up to £500,000 can be made to secure income tax relief at up to 20% with relief being restricted to the amount of income tax otherwise payable. Unlimited capital gains tax deferral relief is also available on an investment in an EIS provided some of the EIS investment potentially qualifies for income tax relief.

(d) Venture Capital Trust (VCT)

The VCT offers income tax relief for tax year 2009/10 at up to 30% for an investment of up to £200,000 in new shares, with relief being restricted to the amount of income tax otherwise payable. There is no ability to defer capital gains tax as with an EIS investment but dividends and capital gains generated on amounts invested within the annual subscription limit are tax free.

For both the EIS and the VCT it is essential that would-be investors are aware of the likely greater investment risk and lower liquidity that will have to be accepted in return for the attractive tax reliefs.