How to reduce your tax

How to reduce your tax

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You can use venture capital schemes to reduce your tax bills. Here’s how.

You have triggered some one-off tax liabilities this year and you are looking for advice on how to mitigate them. You may have already utilised your ISA allowance, so you can’t do anything further there. 

What tax reliefs do the venture capital schemes offer?

Example

You have made both a capital gain and an income tax chargeable event in the previous tax year.

The capital gain arose on the disposal of your buy-to-let property and is £100,000 (after the annual exemption), therefore triggering a capital gains tax (CGT) bill of £28,000.

The income tax gain arose on the surrender of an offshore investment bond and is £50,000, therefore triggering a tax bill of £20,000. You may also have a payrolled amount which is dealt with monthly.

How can you mitigate these tax liabilities, plan for inheritance tax (IHT) and reinvest the proceeds in tax-efficient ways?

Venture capital schemes

Venture capital schemes encourage investment in start-ups and newly trading companies by offering investors generous tax reliefs. There are 3 main HMRC approved schemes: 

  • the enterprise investment scheme (EIS)
  • seed enterprise investment scheme (SEIS)
  • venture capital trusts (VCTs)

The focus will be on the EIS scheme (the SEIS scheme is a similar scheme but comes before EIS if cash is being raised this way).

Enterprise Investment Scheme

EIS offers income tax relief at 30% on the investment in newly issued shares in unquoted trading companies.

An investor can subscribe for shares worth a maximum of £1 million per tax year (£2m if the company is knowledge intensive), and must hold the shares for a minimum of 3 years, otherwise there will be a clawback of the income tax relief received. The investor can elect to carry back the investment if they wish by one tax year so that relief is received in the earlier year.

On a sale of the shares after 3 years, any gain will be completely exempt from capital gains tax (CGT) providing a claim for income tax relief has been made and not withdrawn. There is also the ability to defer CGT arising on the sale of other assets.

These types of shares also automatically qualify for share loss relief, after adjusting for the income tax relief given and not withdrawn.

Venture capital trusts

VCTs also offer income tax relief at 30% on the investment in newly issued shares, although the amount of shares that an investor can subscribe for is £200,000 per tax year and the shares must be held for a minimum of 5 years.

There is no ability for the investor to carry back the investment to the previous tax year, but any dividends received on the shares will be exempt from income tax.

Any gain on the sale of VCT shares will also be exempt from CGT, but unlike EIS, there is no set holding period, therefore shares can be sold at any time and be free of CGT.

Any loss triggered on the sale of VCT shares will not be an allowable loss.

Capital gains tax deferral

One of the most useful benefits of investing in EIS qualifying companies is the ability to defer capital gains arising on the sale of other assets.

Where the proceeds from an asset sale are reinvested into EIS shares within the permitted window, an investor may elect to defer an amount of the gain from being subject to tax.

For every £1 invested into EIS shares, £1 of gain may be deferred.

The deferral window in which you can do this starts 1 year before, and ends 3 years after the date the gain you want to defer arises.

The gain is frozen when you make a claim to defer and is only brought into charge when you sell the EIS shares in the future.

You make the deferral claim by completing the EIS3 compliance certificate that is issued once the relevant paperwork and reporting has been submitted and confirmed by HMRC that the investment qualifies.

As death is not a chargeable event for CGT purposes, if the EIS shares are held until death, the deferred gain will escape a CGT charge.

Using the example above, even though the gain on the sale of the rental property occurred in the previous tax year, the ability to defer the gain is still available due to the generous time period in which EIS investments can be matched. You have from 1 year before disposing of the property to 3 years after to make an investment into EIS shares.

Unlike with the CGT exemption on the sale of the EIS shares themselves, there is no need to have made a claim for income tax relief in order to claim CGT deferral relief. This means that you can be connected with a company and still qualify for CGT deferral.

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Carry-back claim

If you do make a £100,000 investment to defer your capital gain, the flexibility of EIS means that multiple tax reliefs can be claimed on the same investment. 

You can therefore also claim income tax relief at 30% on the investment in addition to claiming CGT deferral relief, i.e. a reduction of £30,000.

Your income tax chargeable event occurred in the 2022/23 tax year, but let’s say that the hypothetical investment would be made in the 2023/24 tax year. If the income tax relief was claimed in 2023/24, you would need to pay the £20,000 tax by January 2024, then offset this by claiming to reduce your bill for the following year.

This isn’t efficient from a cash-flow perspective.

However, there’s a “carry-back” facility which allows some (or all) of the EIS shares to be treated as if they were acquired in the previous tax year.

This would allow you to make a claim to treat £80,000 of the investment as made in 2022/23, offsetting the income gain charge completely. The remaining £20,000 can be claimed in 2023/24, reducing the income tax bill by £6,000.

Inheritance tax

EIS shares have to be in unquoted trading companies; and they will qualify for IHT business property relief after two years of ownership.

By disposing of the rental property and reinvesting the proceeds in EIS shares, you will have turned a non-IHT qualifying asset into a qualifying one.

If the company ever became listed in the future (on a recognised stock exchange) then this protection would be lost.

Use venture capital trusts as an ISA top up?

Having reinvested sufficient proceeds to defer the capital gain and offset the additional income tax charge, you could invest the rest of the proceeds in your ISA, but you have already used your allowance for the year.

Dividends received on VCT shares are tax-free and any gain generated on their sale is tax exempt, therefore a VCT can provide the same tax-free wrapper that an ISA provides, but with the added benefit of having an annual allowance 10x greater and receiving income tax relief on the investment.

There is no IHT relief on VCTs as the investment in the underlying unquoted companies are held by a listed VCT. This is no different to stocks and shares ISAs that are still subject to IHT despite the tax-free wrapper.

You should always contact your financial adviser on anything involving investments. 

Key takeaway

The enterprise investment scheme can be used to offset income tax and defer capital gains tax. It also has the added bonus that the shares should qualify for business property relief after two years. Venture capital trusts offer a more limited income tax relief, but dividends are exempt from tax – meaning they can be used to mimic an ISA, with a larger annual investment limit.

 

SEIS

EIS

VCT

Income tax relief

50%

30%

30%

Holding period

3 years

3 years

5 years

1 year carry back

Yes

Yes

No

Maximum investment

£200k

£1m

£200k

Tax-free dividends

No

No

Yes

CGT free on sale

Yes (after 3 years)

Yes (after 3 years)

Yes

CGT deferral

Reinvestment relief

Yes

No

IHT protection

Yes (after 2 years)

Yes (after 2 years)

No

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