If there was ever a time to consider a shakeup of your investment portfolio, this is it.
The tax changes coming into force at the end of the 2022-23 financial year – in just over a week’s time – mean that you should plan your investments for the coming tax year carefully, taking into account how they might affect your current investments and assets, and what options you have to mitigate any increases in your tax liability.
But what exactly are we dealing with here, and how can EIS investing potentially soften the blow?
Income tax thresholds
What’s changing?
The additional rate tax threshold is falling from £150,000 to £125,140.
What does that mean for me?
It means that if your income is greater than £125,140 annually, you will now pay the 45% additional rate of income tax instead of the 40% higher rate of income tax. For example, if you earn £140,000, you will pay approximately £6,000 more income tax this year.
How does EIS help?
EIS investments offer 30% income tax relief on investments of up to £1m per year, and up to £2m per year if at least £1m is invested in Knowledge Intensive Companies. If you’re among those who find their tax liability changing as a result of the Treasury’s new thresholds, this relief can more than offset the additional income tax you’ll be paying.
Capital gains tax annual exempt amount
What’s changing?
Capital gains tax is payable whenever you sell an asset for a profit, once those gains surpass the annual exempt amount. Currently, that’s £12,300. At the end of this tax year, it will be more than halved to £6,000, and in the following year, halved again to £3,000.
What does that mean for me?
It means that a much larger proportion of any capital gain you make will be subject to tax, and your overall profit from any disposal of assets will be lower. The assets liable for capital gains tax include most shares, property (excluding the house you live in), and possessions like cars, jewellery and so on. If you can sell it for profit, there’s a good chance it’s liable for capital gains tax, with some exceptions.
This is of particular significance for investors who profit from the sale of shares on a regular basis, as more of their profits will be taxed.
How does EIS help?
EIS gives investors several benefits around capital gains tax. The first one is disposal relief on shares held for at least three years. Any gain realised from the sale of shares in an EIS-eligible company are not subject to capital gains tax. So if you invested £10,000 in an EIS fund and one of the companies in your portfolio exited at a profit, leaving you shares worth £100,000, there would be no capital gains tax payable on that £90,000 when you sold them.
EIS investments also offer capital gains tax deferral relief. This allows investors to defer paying capital gains tax on the sale of any asset, as long as that gain is invested into an EIS-eligible company or fund. So if you had realised a £100,000 gain from the sale of an asset, then invested it in EIS, you could defer paying capital gains tax on that gain for as long as you held the EIS shares. On disposal of the shares, you could either pay the tax, or continue to defer it by acquiring additional EIS shares.
Dividend allowance
What’s changing?
The tax-free allowance for dividend tax will halve at the end of this tax year, from £2,000 to £1,000, and then again to £500 in the following year. Dividend payments will be taxed at 7.5%, 32.5% and 38.1% for basic, higher and additional rate taxpayers respectively.
What does that mean for me?
It means that if you receive dividend payments from shares you hold they will become less profitable as a greater proportion will be subject to taxation. This might make certain investment strategies less attractive, for example, buying and holding shares in public companies in order to profit from dividend payments.
How does EIS help?
This one is covered by EIS income tax relief again. With 30% tax relief available, you can offset the additional tax you’ll pay on dividends.
Beyond the tax changes
Outside of the changes made to tax this year, there is the broader economic climate to consider. While the likelihood of recession in 2023 is lower than previously thought, it is not entirely off the table. World events, particularly the Russian invasion of Ukraine, have contributed to a climate of global instability, as well as energy uncertainty, which have caused considerable fluctuations in the public markets.
Many investors view EIS investing as an opportunity to diversify outside of investments in public companies. EIS is a long term investment, taking at least five, and probably ten or more years to mature, and while small companies also feel the pain in a downturn, private markets are less subject to the fluctuations seen in the public markets. In many cases, smaller companies can manoeuvre through a downturn in ways larger companies cannot.
We haven’t even talked about the returns yet.
With so many tax reliefs available through EIS, it’s easy to forget that it also offers the potential for significant returns. This is largely because it is a high risk investment, many startups fail, and returns are never guaranteed.
But when they happen, they can return large multiples to investors. As a general target, most funds work to a 3x return estimate based on growth averages. But you might build a portfolio containing companies that hit 5x, 10x, even 100x or higher. Startup returns follow a power law distribution, which means that a small proportion of the total startup population accounts for the lion's share of returns. Many startups will fail, and many might show reasonable growth. But a small number will see exponential growth, becoming the unicorns of the future.
This potential, taken along with the tax reliefs, may make investing in EIS an attractive opportunity for some investors in today’s climate.
Where to start with EIS investing.
The most straightforward way to get started with EIS investing is to invest in an EIS fund. Funds will deploy your investment into individual companies, conduct the necessary due diligence, and build you a portfolio. You’ll receive EIS3 certificates after you’ve made your investment, and can use the information they provide to make your claim for tax relief. You can also invest into individual companies outside of a fund, but this can bring with it a more significant administrative burden, and you’ll need to conduct the appropriate due diligence on companies you choose to invest in.
The Access EIS Fund
Our fund co-invests with proven angel investors to build large portfolios of hand-picked companies for our investors. It’s a high risk investment, and we can’t guarantee that every startup will be a unicorn, but we’re confident that our approach is the smartest on the market. Even better, we can show you the data to prove it.
If you’re interested and would like to find out the benefits of investing towards the start of the tax year, you can call us on 01223 478 558 and we'll be happy to answer any questions you might have.
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