The 5 main ways to make tax efficient investments in the UK
Saving and investing in a tax-efficient manner has always been a crucial consideration – it can have a significant impact on your returns. And now more than ever, taking steps to maximise returns where possible is key.
To do so, there are a number of tax incentives investors can consider, each with its own focus and benefits, offering investors the ability to choose an approach that best suits their individual investment objectives and personal circumstances
Here is an overview of the five main schemes available to investors in the UK, from the ever-popular Individual Savings Account (ISA), through to the generous Enterprise Investment Scheme (EIS).
1. Individual Savings Accounts (ISAs)
The Individual Savings Account (ISA) will likely be the most well-known tax incentive on this list, with more than 13 million subscribed to in 2019/20 alone and almost 40% of the UK population holding some kind of ISA.
Introduced in 1999 to encourage saving and investing by offering generous tax reliefs, the ISA now comprises a family of products, with the main four being the Cash ISA, Stocks and Shares ISA, Innovative Finance ISA (IFISA) and Lifetime ISA.
Each ISA product covers a specific asset and has its own features and risk profile – for example, the Cash ISA is a low risk cash savings product and the IFISA is a mid–high risk investment product for alternative assets including peer-to-peer loans and debt-based securities. What is consistent amongst all ISAs however is that capital invested or saved is able to grow in an income and capital gains tax-free environment.
Even over 20 years after their introduction, ISAs remain one of the most generous tax reliefs available. Whilst the Cash ISA still accounts for a large proportion of ISA holdings, a sustained period of low interest rates and soaring inflation means Cash ISAs aren’t keeping pace with inflation.
One of the best ways to invest for later life is via a pension, with an annual allowance of £40,000 – or 100% of your income if lower – and tax relief at your prevailing rate of income tax.
It’s worth noting that this allowance is tapered for individuals with an adjusted income of over £240,000 and a threshold income of over £200,000, reducing by £1 for every £2 over your adjusted income, down to a minimum reduced annual allowance of £4,000.
Similar to an ISA, your pension pot is able to grow in a tax-free environment. Once you have paid into a pension scheme, this amount can be invested into allowable assets, which can provide an income or growth without needing to pay tax.
For experienced investors, the Self-Invested Personal Pensions (SIPPs) is becoming increasingly popular, as they allow increased choice over how and where pension funds are invested.
In addition, for Directors of limited companies, the Small Self-Administered Scheme (SSAS) is also an important consideration. A SSAS is set-up by the business’ Director for themselves, their employees and select family members. It allows members' funds to be invested in a broader range of assets, providing the opportunity to build a well-diversified investment portfolio that may include alternative assets with the potential for superior returns, whilst also offering opportunities to be a vehicle of business growth.
As with all pension schemes, they provide tax relief at the prevailing rate of income tax meaning that a £100 contribution would cost a basic-rate taxpayer £80 and an additional-rate taxpayer £55. Any gain made from investments through these schemes will be free of capital gains, meaning any shares in the pension can achieve growth without any risk of paying capital gains when they are sold.
Venture Capital Schemes
For experienced investors – typically those qualifying as high-net-worth individuals or sophisticated investors – there are some generous tax-efficient investment products that form part of the UK Governments Venture Capital Schemes:
- Enterprise Investment Scheme (EIS)
- Seed Enterprise Investment Scheme (SEIS)
- Venture Capital Trusts (VCTs)
This group of schemes are all designed to encourage investment into early-stage companies and promote growth in the next generation of exciting and innovative businesses by offering investors generous tax incentives.
The tax reliefs offered by the EIS, SEIS and VCTs are similar, but the structure of a VCT is somewhat different to that of the EIS and SEIS.
There are a few ways that investors can use the EIS and SEIS, and the approach used by each investor will vary depending on a number of factors including the amount to be invested and their aversion to risk. Experienced high net worth investors or angels may be happier investing directly into a company and taking an active role. On the other hand, someone new to investing or looking to invest smaller amounts may prefer to group together with a large group of investors and may use an online platform to invest.
3. Enterprise Investment Scheme (EIS)
The first of the Venture Capital Schemes, EIS was created as the successor to the Business Expansion Scheme in 1994 and is designed to promote investment into unlisted early-stage businesses. While the scheme has undergone a number of changes over the years the main goal has remained and the scheme has been successful in ensuring a steady stream of capital to the businesses that need it the most, with circa £24 billion of funds raised for over 32,000 early-stage businesses.
This offers investors the ability to invest in younger private companies. These are the companies that are the backbone of the UK economy – the innovators and value creators. However, due to their earlier stage nature, they do carry more investment risk than more mature companies.
This is offset by a range of advantageous tax reliefs, including the headline income tax relief of 30% on the value of your investment, as well as capital gains deferral on invested gains and exemption on the growth achieved. To further mitigate the risk, EIS shares are eligible for loss relief on the net invested amount if the investment doesn't produce a return, potentially reducing the total exposure to 38.5%.
4. Seed Enterprise Investment Scheme (SEIS)
The younger sibling of the EIS, the SEIS was launched in 2012 to cater for the earliest of all businesses seeking investment – earlier than those benefited by the EIS. This scheme provides support for the first £150,000 of external equity capital a business raises within its first two years of trading.
Since the SEIS was established, it has helped over 13,000 companies raise circa £1.4 billion of investment and provided attractive incentives to investors for investing in these earliest stage businesses.
Representing this highest level of risk for investors, the SEIS tax reliefs are similar to but greater than those of the EIS, with 50% income tax relief upfront and reinvestment relief that allows investors to reclaim 50% relief on a reinvested gain. These, along with the similar capital gains exemption on disposal and loss relief, ensure a potential total exposure as low as 13.5%.
Investing in start-up businesses can be exciting and rewarding, and investing right at the beginning of the growth journey can provide a significant opportunity for capital growth.
5. Venture Capital Trusts
More of a cousin than a sibling to the Enterprise Schemes – though the tax reliefs can be similar – VCTs take a slightly different structure for investment and allow a wider range of companies.
Launched in 1994, shortly after the EIS, a VCT is a listed company in its own right that pools investment to then distribute to build a managed portfolio of investments into eligible companies. Being a managed investment structure, the VCT will hold a diverse portfolio of investments into early-stage unlisted and AIM listed businesses on behalf of the investors.
As this structure allows investment into slightly later stage businesses, the reliefs offered are slightly less generous, but this represents the reduced risk profile of these companies. Income tax relief of 30% can be claimed upfront and the dividends paid are not subject to income tax without affecting your dividend allowance for the year. Similarly, the growth that is achieved is not subject to capital gains tax, however, the loss relief offered through the more risk-focused investments is not available for this managed approach.
While VCTs are always a managed approach to tax-efficient investing, both the SEIS and EIS offer a choice of managed or direct investment. Both of these usually require the investor to choose how they invest and to carefully assess each opportunity as part of their due diligence. However, for investors who wish to have their investment managed, there are SEIS and EIS funds available from many firms.
As the name suggests these funds invest solely in eligible companies and all contributions into the fund provide the same tax reliefs to the investor as if they had invested directly, including income tax relief and capital gains exemption on sale. However, the managed approach attracts fees from the managing company, usually both at the point of investment and annually, which can sometimes be a significant amount over the lifetime of the investment.
These three approaches have their own limits, both in terms of holding time (5 years for VCTs and 3 years for SEIS or EIS), and the amount that can be invested in each (£200,000 for VCTs, £100,000 for SEIS and for EIS. Though for the EIS, this is more complex – there's an annual limit of £1,000,000 each year, but a further £1,000,000 can be invested if this additional amount is into a knowledge-intensive company).
Making a tax-efficient investment
It's clear that a number of routes exist for individuals keen to invest for tax-efficient purposes, offering investors a broad scope of opportunity to make a choices suited to their own individual preferences and tax circumstances.
Whether investors are looking to achieve positive returns, positive impact or both, GCV's free guide to tax-efficient investing can offer a more in-depth insight into the UK's most effective tax efficient investments and how to access them.
Please Note: The value of investments and any income from them can fall and you may get back less than you invested. Please note that this article was prepared as a general guide only and does not constitute tax or legal advice.
While we believe it to be correct at the time of writing, Growth Capital Ventures is not a tax adviser and tax law is subject to frequent change.
Tax treatment depends on your individual circumstances; therefore you should not rely on this information without seeking professional advice from a qualified tax adviser.
The opinions expressed in this document are not necessarily the views held throughout Growth Capital Ventures Limited. No investment is suitable in all cases and if you have any doubts as to an investment's suitability then you should contact a qualified tax adviser.