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The 5 main ways to make tax efficient investments in the UK

Whether your saving or investing, tax efficiency is a key consideration as it can make such a huge difference to your overall wealth and ultimately your quality of life as these savings and investments mature.

There are a number of ways that investors can invest tax-efficiently, each with its own focus and benefits, giving investors the ability to choose an approach that best suits their priorities and personal circumstances.

In the UK, savers and investors can benefit from a number of tax-efficient investment products introduced by the UK Government to encourage saving and investment. Here’s an overview of the five main schemes. 

 

1. Individual Savings Accounts (ISAs)

Individual Savings Accounts, or ISAs, will almost certainly be the most widely recognised investment method on this list. Introduced in 1999, the term ISA now accounts for a family of products that are available to all savers in the UK and allow them to benefit from a number of reliefs. The government set them up to encourage saving and investment by offering generous tax breaks. With an ISA you can invest up to £20,000 a year without paying tax on the investments. Since the introduction of the original ISAs, the government has introduced other types, so there are now seven and the main four are; Cash ISAs; Stocks and Shares ISAs; Lifetime ISAs; and now, Innovative Finance ISAs (IFISA). 

Capital invested into an ISA is allowed to grow in a tax-free environment, meaning that any income, be that interest for Innovative Finance ISAs or dividends or capital growth for Stocks & Shares ISAs will be exempt from the respective taxes.

For investors, the Stock & Shares ISA allows them to invest in listed shares and specialist funds.  As with all investments, capital is at risk and the values of investments can increase and decrease depending on market conditions.  Stocks and Shares ISAs typically perform well over a longer hold period.

When they were introduced these were one of the most attractive ways for general savers to invest their capital for tax efficiency. This led to ISAs becoming a leading product for most households, with 40% holding an ISA and only current accounts being held by a greater proportion (93%).

Since their introduction in 1999, ISAs have proved popular for the most savers and investors with over 40% of the UK population holding some form of ISA.  Cash ISAs still account for a large proportion of ISAs, however, a sustained period of low interest rates means Cash ISAs are struggling to keep pace with inflation.  The volatility of the stock market has also posed challenges for investors.  More experienced investors are therefore turning to the Innovate Finance ISA in search of inflation-beating returns and portfolio diversification.

The IFISA continues to grow in popularity, introduced in 2016 allowing individuals to use some, or all, of their annual ISA investment allowance to lend funds through the peer to peer lending market and buy other debt-based securities, getting the usual ISA benefits of tax-free interest and capital gains.

2. Pensions

The next - hopefully - a well-known way to invest in a tax-efficient way is through pensions. Pension contributions up to the annual allowance of £40,000 - or 100% of your income if lower - can be made with tax relief at your prevailing rate of income tax. This allowance tapers over £150,000, reducing by £1 for every £2 over the £150,000. The effect of this is that contributions are effectively tax-free up to your annual allowance.

Your pension pot is allowed to grow in a tax-free environment, so as with ISAs, 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.

Self-Invested Personal Pensions (SIPPs) are becoming ever more popular with experienced investors who want more choice on how pensions can be used to invest. Small Self-Administered Schemes (SSASs) are another pension wrapper that is becoming more popular too.  The SSAS Pension is designed for Business Owners and controlled by the pension scheme Trustees and 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 superiors returns.

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 more experienced investors, typically those qualifying as High Net Worth Individuals or Sophisticated Investors, there are some very interesting tax-efficient investment products that form part of the UK Governments Venture Capital Schemes;

  • Enterprise Investment Scheme - EIS
  • Seed Enterprise Investment Scheme
  • Venture Capital Trusts

This group of schemes all offer similar tax reliefs and structures and are designed for tax-efficient investment into early-stage businesses to promote growth in the next generation of exciting and innovative British businesses.

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, but on the other side, someone new to investing or only 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 over £16.2 billion of funds raised up to October 2017.

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, SEIS was launched in 2012 to cater for the earliest of all businesses seeking investment. This scheme provides support for the first £150,000 of external equity capital a business raises within its first two years of trading. By October 2017, SEIS had helped 6,665 companies raise over £621 million 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 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. Investing in a business right at the beginning of the growth journey can provide a significant opportunity for capital growth. However, many startups fail and other may not go on to achieve the initial growth aspirations - for those that do - the returns for investors may well be very lucrative. 

5. Venture Capital Trusts

More of a cousin than a sibling to the enterprise schemes, VCTs take a slightly different structure for investment and allow a wider range of companies, though the reliefs can be similar to the two schemes.

Launched in 1994, shortly after 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 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, as you would expect 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, 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

As you can see , 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.

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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.

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