Investment schemes are more efficient together

This article is part of
Tax Efficient Investing - March 2015

Speakers at a recent seminar in London on the theme of tax-efficient investing outlined the roles of investment schemes, including the imminent advent of Alternative Investment Market (Aim) Isas.

Most of those investments and tax breaks could be even more effective if considered and used in combination, which would appear an obvious conclusion in the tax-planning area of financial services.

But sadly people working in these various different specialisations seem to operate in their own well-defined silos.

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Taxpayers who gift assets into various types of trusts and then survive seven years see those assets subsequently fall out of account.

One of the major problems with this approach is that such a gift of pre-existing assets would be liable for capital gains tax (CGT).

If the taxpayer has a house worth £1m, the general rule is that everything else is going to incur an inheritance tax (IHT) charge of 40 per cent on death.

So imagine that person has cash, a number of Isas and a general investment portfolio of £800,000 on which there is a gain of £200,000.

To place just half of that portfolio (£400,000) into a trust would realise a gain of £100,000 on which they would pay 28 per cent CGT, thus diluting the amount available to gift by £28,000.

This is where another tax-efficient investment scheme can come to the rescue.

If that taxpayer places the equivalent gain of £100,000 into an enterprise investment scheme (EIS), several benefits emerge that could put them in a dramatically improved position compared with the straightforward trust approach.

Such an investment would permit the original portfolio gain of £100,000 to be deferred – an immediate plus.

At the same time there would be a qualification for a 30 per cent (£30,000) reduction of income tax paid in the current or preceding year – a £30,000 cash-back.

It is even better from an IHT perspective because while the balance of £300,000 in the trust scheme would fall out of account after seven years, the EIS investment falls out of the IHT net after only two years.

The only perceived drawback would be an EIS investment into a more risky investment sector, but there are two consolations here.

First, in reality there are many lower-risk EIS investments. Second we are talking about less than 12 per cent of the taxpayer’s overall portfolio being invested in higher-growth areas, acceptable by most investors’ risk profiles. This is quite apart from the other tax benefits associated with an EIS investment.

On the other hand, should an investor buy into an Aim portfolio, there are fewer CGT deferral and income tax benefits.

But since the shares are tradable, they can be transferred/gifted after two years on an IHT-exempt basis into a flexible trust, after which time they can be traded back into more conventional investments but permanently remain outside the IHT net.

There are plenty of creative variations on all of these ideas and another recent innovation relates to Isas.