Tools of the trade

This article is part of
Annual Tax Planning - February 2014

At the same time, many are concerned by all the recent publicity about tax-avoidance schemes.

A client does not want to see his photo on the front page of the tabloids, under a headline berating the latest tax avoider. This could therefore be a very good time to consider the benefits of the Enterprise Investment Scheme and Venture Capital Trust regimes.

An investment in an EIS or in a new VCT gives income tax relief of 30 per cent of the amount invested, provided you have that much tax liability in the first place.

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For example an investment of £100,000 will give you tax relief of £30,000 if you have an income tax liability of at least £30,000. The maximum you can invest to gain this relief is £1m with an EIS or £200,000 with a VCT.

With an EIS you can also carry back one year, so you could invest up to £2m and gain up to £600,000 income tax relief. Carry back is not available with a VCT, so the maximum tax relief is £60,000.

Investors must hold EIS shares for at least three years and VCT shares for at least five years, otherwise the initial income tax relief will be withdrawn.

An EIS or VCT investment does not reduce taxable income. This is helpful if you are trying to fund a pension to its maximum at the same time, but it also means this type of investment is not suitable if you want to reduce taxable income – for example to avoid the child benefit charge or a reduction in your personal allowance.

An EIS can also be used to defer any amount of capital gain. There is no £1m limit for this purpose. The gain must have arisen between one year before and three years after the EIS investment. Any entrepreneurs’ relief will be withdrawn when the gain is deferred, but where you have no intention of ever disposing of the EIS and triggering the gain it may still be advantageous to defer it.

An investment in an EIS is free from inheritance tax provided it is held for at least two years. Gains in an EIS are not subject to capital gains tax provided the investment qualified for income tax relief. For an investment over £1m (or £2m if using full carry back), gains on the excess will be subject to tax. This rule also means the gain will be taxed if the investment is disposed of within three years.

Losses in an EIS can be offset against taxable capital gains. Alternatively, you can offset the losses against taxable income in the current or previous year.

Income tax is payable on dividends. As most EIS investments are in companies at growth stage there is not usually an intention to declare dividends in those early years anyway.

Additional tax benefits of VCTs