Our previous blog in May 2018 explored the Tapered Annual Allowance and how subject to certain criteria, the annual pension allowance on which you receive tax relief may be reduced (to a minimum of £10,000) for those earning over £150,000. For those who have already managed to build up sizeable pension pots, the lifetime allowance currently stands at £1.03m (due to increase in line with inflation) and any excess over this figure will incur tax when tested that could negate the benefits of making pension contributions.

We are therefore seeing increasing numbers of clients who have maximised their pension contributions and have significant excess income with which they can look to use other allowances.

The first step would be to review your goals and ensure that any relevant ISA allowances, Junior ISA allowances or pension contributions for spouses and/or children are made. Unwrapped portfolios and other tax wrappers such as investment bonds may also meet the needs of many clients and should be considered at this point. Further details on the current tax year’s allowances can be found here

However, for those individuals who have made use of their relevant allowances and are looking for further opportunities for tax efficient investments, Venture Capital Trusts (VCT) and Enterprise Investment Schemes (EIS)/Seed Enterprise Investment Schemes (SEIS) offer some attractive headline reliefs.

These products are a government sanctioned venture capital schemes designed to encourage investment in small companies that are not listed on a recognised stock exchange. Both VCTs and EISs are considered high risk ventures and therefore are only suitable for a small number of investors.

The key difference in terms of the actual structure of the schemes is that a VCT is a listed fund, whereas an EIS scheme is not. In theory this means that VCTs are the more liquid product as you could simply sell the shares, whereas with an EIS you must wait for an exit opportunity (stock market floatation, management buy-out, trade sale etc.) to realise the investments. However, in practice VCTs can often be illiquid and trade at a discount to their net asset value (NAV).

Venture Capital Trusts (when purchased as new shares)

• Income Tax relief at the rate of 30% on the amount subscribed for the shares, up to a £200,000 subscription limit in a tax year as long as they are held for at least 5 years.
• Exemption from Income Tax on dividends.
• Exemption from Capital Gains Tax (CGT) on disposal of the shares.

Enterprise Investment Schemes

• Income Tax relief at the rate of 30% on the amount subscribed for the shares, up to a £1,000,000 subscription limit in a tax year as long as they are held for at least 3 years. The Income Tax relief can be carried back to the previous tax year.
• Exemption from CGT on disposal of the shares if they are held for at least 3 years.
• If shares are sold at a loss, you can elect that the amount of the loss (less any I.T. relief) can be set against income rather than CGs.
• The payment of tax on a capital gain can be deferred when the gain is invested in EIS shares/fund. The investment must be made up to 1 year prior or 3 years after the gain arose. There is no minimum period, the deferred CG is brought back into charge when the shares are disposed of.
• Shares do not form part of the estate for Inheritance Tax purposes, provided the investments have been held for at least 2 years at time of death and the company qualifies for Business Property Relief (“BPR”).

Seed Enterprise Investment Schemes

SEIS’s share a lot of the same reliefs as regular EIS’s, however have some exceptions where they are more generous, reflecting the increased risk of investing in smaller companies. The main differences are:

• The Income Tax relief is at a rate of 50% (rather than 30%) on the amount subscribed for the shares, however SEIS has a reduced subscription limit of £100,000 in a tax year.
• Rather than deferring a capital gain as is the case with EIS’s, a Capital Gain can be made wholly exempt from tax if it is invested in SEIS shares/fund. An investor can qualify for CGT relief on 50% of the investment, up to the subscription limit of £100,00 (i.e. maximum relief of £50,000).

Whilst both VCT and EIS products both benefit from 30% income tax relief, they have significantly different structures and benefits, which will need to be carefully assessed against a client’s needs and objectives. VCT’s offer tax-free income in the form of dividends which can be a useful top up to an existing income. However, the larger investment limit of £1m, Capital Gains Tax deferral, ability to set losses against income and potential BPR qualifying status of EIS can make it an attractive option. It’s therefore important to assess whether additional income, CGT planning or estate planning is more important. The products can be considered to be complementary and for some clients, a combination of EIS and VCT might be a potential solution.

As with any investment, ensuring that the underlying securities are of a suitable quality is the main priority. Changes were made to the EIS legislation in 2015, tightening the definitions of qualifying companies by introducing rules which stated EIS only applied to companies that had been trading for 7 years, amongst other. Furthermore, HMRC has recently introduced a ‘capital preservation purpose test’ which aims to weed out those schemes which are simply low-risk tax shelters and ensure that there is an actual risk to capital. It’s important to understand the legislative risk of these schemes (i.e. a company becoming non-qualifying and therefore reliefs being lost) and we would only recommend those schemes which are investing in the true spirit of the legislation by investing in genuine growth businesses.

The nature of VCT and EIS investments means that an investor will be exposed to smaller companies and therefore a higher level of risk than, for example, a fund of large cap equities. Whilst some of the risk of a drop in capital value will be offset by the initial tax reliefs, we would generally look at these products only for investors who a comfortable with the possibility of a 100% loss of the invested capital.

This blog has only briefly touched on the subject matter, VCT and in particular EIS schemes can involve some complex planning and it’s therefore essential that you seek advice before considering investing. Not all schemes are of equal quality and the experience, financial stability and diligence of the scheme/trust manager is extremely important. At Five Wealth we review the whole marketplace in order to recommend the best quality schemes. If you would like to discuss the content of this blog or would like any further information about VCT and EIS products, please contact us.

Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. Tax relief depend on scheme maintain their qualifying HMRC structure.

Following on from Liz’s blog in regard to the new tax year specific allowances. Jordan wanted to provide a more detailed explanation of the Tapered Annual Allowance and how this could affect you.

The Tapered Annual Allowance was announced by George Osborne in the Summer 2015 Budget but and came into effect a year later on the 6th April 2016. Although this will be the third year of the tapering system it is still a very complex and difficult topic to understand. If you think you might be affected by the Tapered Annual Allowance, it is vital to seek advice from a professional.

Purpose of the Tapered Annual Allowance

The change was intended to reduce the amount of income tax relief available to higher earners who make pension contributions and to reduce the amount of government spending on pension tax relief.

The annual allowance restricts the amount of pension contributions you can receive income tax relief on. The standard annual allowance (the maximum gross amount you can pay into pension) is £40,000 in the current tax year but, if you are subject to the tapered annual allowance this could be reduced to £10,000.

Who is affected?

If your total taxable income is under £110,000 in the 2018/19 tax year, then you should not be affected. Please note the phrase “total taxable income” includes all sources of taxable income and some pension contributions (it is not limited to just your salary).
To see if you might be affected by the tapered annual allowance you can follow these 3 easy steps:

1. Calculate your total income before tax from all sources (Gross total income includes employment income, pension income, rent, bank interest, dividends – essentially any taxable income).
2. Include any new salary exchange or salary sacrifice arrangement which was set up or changed on or after 9th July 2015.
3. Deduct the gross value of any pension contributions you paid under the relief at source method of calculating income tax relief (personal pension contributions).

This is your threshold Income.

If this figure is less than £110,000 you should not be affected by the tapered annual allowance. This means you should continue to be subject to the standard annual allowance of £40,000.

What if I earn over £110,000?

If this is £110,000 or more, you now need to calculate your Adjusted Income:

1. Calculate your total income before tax from all sources (ignoring deductions for pension contributions).
2. Add the value of any pension contributions[1]paid by your employer. This includes contributions paid under a salary sacrifice or salary exchange system, regardless of when this system was originally set up.

This is your Adjusted Income. If this is less than £150,000 you should not be affected by the tapered annual allowance. This means you should continue to have the standard annual allowance.

What if I earn over £150,000?

If this is more than £150,000 you now need to do the following to find your tapered annual allowance:

1. Take your adjusted income figure
2. Deduct £150,000
3. Divide this by 2
4. Subtract this figure from £40,000

This should be your tapered annual allowance for the 2018/19 tax year. If this figure is less than £10,000 your tapered annual allowance is £10,000 (the lowest tapered annual allowance you can have is £10,000 – this will apply to anyone with adjusted income of more than £210,000).

Importantly you can still use any unused annual allowance from the 3 previous tax years on top of your tapered annual allowance under the standard “carry forward” rules. This can allow larger contributions than £40,000 which can maximise tax relief especially for higher earners.

What if I exceed the tapered annual allowance or the standard annual allowance?

You will face an annual allowance charge, which essentially removes the additional income tax relief you received on your pension contribution. This can sometimes be paid by your pension scheme, but it is normally paid by you directly.
You are responsible for ensuring you pay any annual allowance charge due. This will not be automatically done by HMRC, your employer or your pension provider.

What if I’m not sure what to do?

This subject is very complicated, it is recommended you seek professional advice if you think you may be affected or have exceeded the annual allowance. We can find out if you are affected and offer advice on the most suitable way of dealing with this issue, including alternative methods of saving for your retirement or structuring your pension contributions differently.

Any reference to taxation will be based on your individual circumstances. Tax legislation and regulations are subject to change. Investments, and the income from them can fall as well as rise. Your capital is not guaranteed.

For a defined contribution pension this is simply the monetary amount paid by your employer. For a defined benefits pension this is more complicated: it is the annual increase in your defined benefits scheme pension benefits from your employer only.

Now that we have entered the 2018/19 tax year, this brings about a refresh of your tax-year specific allowances. We wanted to provide a short summary of the new allowances available, many of which provide valuable investment opportunities.

Personal Allowance – £11,850

The personal allowance has increased by £350 to £11,850, with income within this not being subject to income tax. As a brief reminder, the personal allowance is available for all individuals, however is reduced by £1 for every £2 of income above £100,000 (completely lost at £123,700). Marginal rates of income tax remain unchanged at 20%, 40% and 45% for income received in excess of the personal allowance.

Capital Gains Tax (CGT) Allowance – £11,700

The CGT allowance has increased by £400 to £11,700, with any realised gains up to this level not being liable to CGT. For Trusts, the allowance remains at half of the level available for individuals (£5,850). Any gains realised above the allowance will continue to be taxed at 10% or 20% depending on your marginal rate of tax (higher rates for residential property gains).

Dividend Allowance – £2,000

The dividend allowance has reduced from £5,000 (2017/18) to £2,000, with any dividends in excess of this allowance being tax at marginal dividend rates (7.5%, 32.5%, 38.1%). It is important to remember here that the dividend allowance essentially utilises £2,000 of your basic-rate band and should your income level already be fully utilising your basic rate tax band, this would push £2,000 of taxable income into the higher-rate tax band (40% tax rather than 20%).

It is important that portfolios are structured in the most tax-efficient way to utilise these three allowances. For example, considering the transfer of dividend producing assets to a spouse that pays a lower marginal rate of tax or managing the taxable gains within a portfolio on an ongoing basis.

ISAs

Cash ISAs/Stocks & Shares ISAs – £20,000

Junior ISAs (JISA) – £4,260

Lifetime ISAs (LISA) – £4,000

The cash/stocks & shares ISA allowance is remaining unchanged at £20,000, and during the course of the year the allowance can be split between the two types of plan. For those wishing to maximise the allowance using monthly investments, these would need to be at a level of £1,666.66 pm. ISAs remain one of the most tax-efficient wrappers, being free from all forms of personal taxation (income tax, CGT, dividend tax) and should be the first point of call to accumulate capital on an annual basis.

The Junior ISA limit is increasing from £4,128 (2017/18) to £4,260, meaning that a further £132 can be invested for children. JISAs remain a tax-efficient way for parents/grandparents/family members to save for children throughout their minor years, with no access to the capital until the age of 18 when the plan would convert to a stocks & shares ISA (although control of the plan is given at 16).

For those looking to invest into LISAs, the allowance is remaining unchanged at £4,000. These products are aimed primarily at those looking to buy their first house, or those looking to save for retirement (post 60), for which 25% bonuses from HMRC can be earned. For any other withdrawals, investors are charged a 25% penalty which effectively removes this bonus.

Pensions – £40,000 gross

For the new tax year, the pension annual allowance is remaining unchanged at the lower of £40,000 (£32,000 net) or the level of earned income. For those with no earned income (including children), the maximum annual contribution remains at £3,600 gross (£2,880 net). For those with total income in excess of £150,000, the annual allowance is tapered down at a level of £1 for every £2 of income, to a minimum level of £10,000, with this being the third year of the tapering system. This tapering is a complex topic, and we will be looking to produce a blog in the coming months which focuses on this in more detail.

Pensions remain a very attractive option for investors, with tax relief being able to be achieved at your highest marginal rate on any personal contributions, and companies being able to classify employer contributions as business expenses. In addition, under current legislation most pensions are not included as part of your estate when being assessed for Inheritance Tax (IHT).

The aim of this blog is to highlight the allowances available to individuals now that we have entered the 2018/19 tax year. If you have any questions at all then you should contact your adviser.

Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The Financial Conduct Authority does not regulate Tax Advice.