- Churchill Tax
Which tax incentivised investment is best for you?
Last year windfall income resulted in a big hike in your tax bill. You’ve heard it’s possible to retrospectively reduce it by investing in a tax incentive scheme. As there are several, which offers the right tax breaks for your situation?
Investment risk
It’s important to say that all investments carry risk and tax incentivised investments tend to be riskier than average. We therefore recommend speaking to a financial advisor before investing. In this article we’re comparing the tax perks of enterprise investment schemes (EISs), seed EISs (SEISs) and venture capital trusts (VCTs).
Key tax breaks for EIS investors
Income tax:
Where the anti-avoidance rules apply to assets owned by a foreign company, capital gains it makes are taxable on the companUnlike most tax relief, EIS relief doesn’t reduce the amount of income on which you’re taxed but is simply knocked off your tax bill. The amount of tax relief you receive is equal to 30% of the amount you invest. For example, if you invested £50,000 in an EIS company your tax bill will be reduced by £15,000. Tip. Whatever rate of tax you pay you’ll get the same amount of tax relief. y’s shareholders as if they had make the gains personally. The gain taxable on each shareholder is in proportion to their shareholding in the company.
TRAP:
If your tax bill for a year is less than the EIS relief you’re entitled to, the excess relief is lost. For example, if your tax bill is £20,000 and you’re entitled to EIS relief of £22,000, your tax bill is reduced to zero - the other £2,000 is wasted.
TIP:
You can avoid the above trap by carrying back some or all of your EIS relief to the previous tax year.
NOTE
An EIS investment is in shares in an EIS company. Dividends paid on these are taxable in the same way as dividends from non-EIS companies.
Capital gains. EIS investments also allow you to defer a capital gain. This extra relief applies only if you receive EIS income tax relief. It works by reducing the amount of capital gains, pound for pound. The deferred gain becomes chargeable in the tax year in which you sell or transfer your EIS shares.
TIP:
Any growth in value of EIS shares is exempt from capital gains tax (CGT) when you sell or transfer them.
Inheritance tax
The value of your EIS investment usually qualifies for inheritance tax (IHT) business property relief if you’ve owned it for two or more years. That means if you gift it during your lifetime or through your will it is ignored for IHT purposes.
Key tax breaks for SEIS investors
The tax breaks for SEIS investments are the same as those for EISs except for two key differences:
• Income tax relief is equal to 50% of the amount you invest.
• CGT relief is given as a 50% exemption instead of a 100% deferral.
For example, you made a capital gain of £80,000 in 2021/22, and invested £60,000 in an SEIS company in the same year (or the following year and elected to carry back income tax relief) you’re entitled to exempt £30,000 (£60,000 x 50%) of the gain from CGT.
• Income tax relief is equal to 50% of the amount you invest.
• CGT relief is given as a 50% exemption instead of a 100% deferral.
For example, you made a capital gain of £80,000 in 2021/22, and invested £60,000 in an SEIS company in the same year (or the following year and elected to carry back income tax relief) you’re entitled to exempt £30,000 (£60,000 x 50%) of the gain from CGT.
Key tax breaks for VCT investors
The tax breaks are more limited for VCTs. On the other hand VCTs tend to be less risky investments compared with EISs and SEISs.
• 30% income tax relief as for EISs and SEISs but carry back is not allowed.
• Income (dividends) from a VCT isn’t liable to tax.
• Any growth in value is exempt from CGT.
• 30% income tax relief as for EISs and SEISs but carry back is not allowed.
• Income (dividends) from a VCT isn’t liable to tax.
• Any growth in value is exempt from CGT.
TRAP:
Unlike EISs and SEISs a VCT doesn’t entitle you to defer or exempt other gains from CGT.
Conclusion
You can reduce your income or capital gains tax (CGT) for the year before your investment in a tax incentive scheme with an enterprise investment scheme (EIS) or seed enterprise investment scheme (SEIS). This isn’t available for venture capital trust (VCT) investments. Income tax relief for each is equal to 30% of what you invest but EISs and SEISs provide CGT and inheritance tax reliefs which VCTs don’t.