What are tax-efficient investments?
Tax-efficient investments are government-approved schemes that give investors tax relief (also known as "tax breaks") on investments into qualifying companies or investment vehicles. These reliefs range from Capital Gains Tax relief through to loss relief and Inheritance Tax relief.
The following are some of the tax-efficient investment opportunities available to UK investors.
It's worth noting that not all investors qualify to receive tax relief from all of the tax-efficient investments covered below. If you have any doubt about your eligibility, consult an accountant or read through the full conditions on the HMRC website.
Investing in startups
Early-stage investing is risky by nature: these businesses are small, unproven sailboats with limited resources on a turbulent ocean of public opinion, market shifts and competing incumbents. Nine out of ten startups sink within the first four years.
Despite the odds – or perhaps because of their thrill – many individual investors continue to support the small, enterprising companies seeking to change the world, and in so doing take advantage of the EIS and SEIS – two of the most generous tax incentives in the world.
The Enterprise Investment Scheme
The Enterprise Investment Scheme (EIS) was launched in 1994 to encourage investments in small, high-risk companies in the UK – i.e. to encourage people to invest in startups. Eligible EIS investments allow you to take advantage of the following reliefs on up to a cap of £1m per tax year (or £2m per tax year as long as at least £1m of this is invested in knowledge-intensive businesses):
- Income Tax relief of 30% of your investment. This can be used in the year of investment or carried back one year
- Capital Gains exemption on profits earned on shares held for a minimum of three years
- Loss relief, should the company you’ve invested in fail, equivalent to your tax bracket multiplied by your ‘at risk capital’ (the total loss on the shares once Income Tax relief has been accounted for)
- Capital Gains deferral on gains realised on the disposal of any asset which is reinvested in an EIS eligible company
- Inheritance Tax exemption on shares held for a minimum of two years
The Seed Enterprise Investment Scheme
The Seed Enterprise Investment Scheme (SEIS) is a tax efficient investment designed to complement the EIS by helping small, early-stage companies. It does this by offering tax reliefs to individual investors who purchase new shares in those companies. Income tax relief is available on qualifying shares, to people who have UK tax liability against which to set the relief. Shares must be held for three years from date of issue in order for relief to be retained in full.
Tax relief is available at 50% of the cost of the shares, on a maximum investment of £100,000 per annum.
Like with the EIS, the SEIS has a carry-back facility that allows for part or all of the cost of the shares acquired in one tax year to be treated as though the shares had been acquired in the preceding tax year, thereby securing relief for the earlier year.
SEIS is applicable to shares issued on or after 6 April 2012.
Individual savings accounts
ISAs can be used to save cash, or to invest in stocks and shares.
For the 2017/18 year tax year, you may pay an annual allowance of £20,000 into a cash ISA, a stocks and shares ISA, or one of each in any tax year. You pay no income tax on the dividends or interest that you receive from an ISA, and any profits you receive from investments are free of capital gains tax. Learn more about ISAs here.
You must be over 16 to qualify for a cash ISA, and over 18 for a stocks and shares ISA; for under-18 ISAs, see Junior ISAs below.
Flexible ISAs, which were introduced in the UK in 2016 as a new entry in the tax-efficient investing field, function a lot like cash ISAs but with an added flexibility. You can take money out of a Flexible ISA at any point and return it in the same tax year without it reducing your current year's tax-free allowance.
The Help to Buy ISA, which is designed to help first-time buyers save money towards buying their first home.
After an initial deposit of £1,000, you'll receive a £50 bonus for every £200 saved, to a maximum bonus of £3,000. As with a standard ISA, any interest you earn will be tax free. Help to Buy ISAs will be limited to one per person and you will not be able to contribute to a Cash ISA in the same tax year.
Innovative Finance ISA
Available since 6th April 2016, the Innovative Finance ISA entitles lenders to tax-free interest in loans arranged through peer-to-peer (P2P) platforms.
A Junior ISA lets you build up a child’s savings and earn tax-free interest. Friends and family may add money to the account on behalf of the child up to the savings limit. The savings limit for Junior ISAs is £4,080 for the 2015/16 tax year, though this limit may change in future; check the UK Government website for updates.
There are two types of Junior ISA: cash, and stocks and shares. A child may have one or both types of Junior ISA, and there is no income tax nor capital gains tax payable on interest or investment earnings.
Junior ISAs are available to any children under the age of 18 who are living in the UK, so long as they don’t qualify for a Child Trust Fund. The child can take control of the account after they turn 16, but cannot withdraw money until the age of 18.
Venture Capital Trusts
VCTs offer investors exemption from income tax on dividends on ordinary shares, and income tax relief of 30% on the value of new ordinary shares subscribed (capped at £200,000 per tax year) providing that shares are kept for at least five years. You may also be able to get disposal relief through VCTs.
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