Spotting clients that could benefit from tax-efficient investments
14 December 2020
Recommending Venture Capital Trusts and EIS investments.
Beyond pensions and ISAs, how can you help clients invest for the future tax efficiently?
This article is about some tax planning opportunities that could exist in your client bank today. And how two tax-efficient investments could help unlock those opportunities.
A good place to start is high-earning clients. Many of these clients will make full use of their annual ISA allowance, and make significant pension contributions that have compounded over the years.
This was an important client type addressed by Mike Hodges and Alistair Candlish of Carrington Wealth Management, when they featured on the recent Octopus tax planning show.
“There’s a lifetime allowance now on the total sum of your pension,” says Alistair. “And once clients have gone through that allowance, they ask ‘why should I keep adding if I’m going to get taxed later at a higher rate?’”
“Clients are putting pensions to one side now and saying, ‘I’ve done that, now I’ve got to look at other options.’”
Complementing pension planning and other arrangements
One option is a Venture Capital Trust (VCT). These are pooled investments where a client invests in one large, listed company, which in turn invests in a portfolio of small companies.
An investor can claim up to 30% income tax relief on the amount invested in a VCT, on up to £200,000 invested each tax year.
“With VCTs you’ve got an initial income tax relief that you can compare to the tax relief on a pension contribution to some extent,” says Alistair.
“You’ve then got, which I think is a really good feature, tax-free dividends while holding the investment.”
For these reasons, VCTs have become an attractive complementary way to invest for retirement. But it’s important to set expectations with a client, including the risks.
“You need to help a client understand what to expect from a VCT investment, and the time they have to hold one. A client should only have assets in there they don’t need access to, and they should expect a minimum five-year hold to qualify for tax reliefs.”
Tax planning opportunities aren’t restricted to high earners
“Landlords can of course claim income tax relief against their rental income when investing in a VCT. This is very helpful,” says Mike.
Where landlords want to invest rental income for retirement, pensions require you to contribute relevant earnings, typically from employment which a landlord may not have. Also, landlords can no longer deduct all their mortgage from rental income. This means some landlords have turned to VCTs to invest their rental income tax-efficiently.
Similarly, you might want to think about business owners who want to extract money from their business.
“A lot of business owners do take income in the form of dividends. And the income tax relief can be claimed against this.” says Alistair.
Business owners investing proceeds for the future
“Quite often a client is waiting for a big pay day when they sell their business. When that happens, we’re looking at what sort of tax planning we can do,” says Mike.
Where a client has sold a business and wants to make investments for the future, a portfolio of investments that qualify for the Enterprise Investment Scheme (EIS) is an option to consider.
Investing some of the proceeds from the sale of a business in such a portfolio allows an investor to claim up to 30% upfront income tax relief on their investment amount and target tax-free capital growth.
Of particular relevance in this scenario are two further reliefs: capital gains tax (CGT) deferral relief and Business Property Relief (BPR).
CGT deferral relief lets a client invest some or all of the capital gain realised on the sale of their business and defer the capital gains tax until a later date.
If the investor still owns the shares in EIS-qualifying companies when they die, they can be left free from inheritance tax (BPR qualification). If this occurs the deferred gain will also be permanently eliminated.
Bear in mind that any companies invested in must remain qualifying for three or more years in order to make use of these tax reliefs. And also bear in mind that the generous tax reliefs exist because the investments are high risk.
Understanding the EIS structure and who it’s for
An EIS service can be a great structure through which to target high growth from high-risk portfolios. It tends to appeal to experienced investors who want to pursue growth over the long term.
With an EIS service, investors directly own shares in a portfolio of small companies with the potential for high growth. This structure is therefore illiquid, because there is no way to sell an investor’s portfolio until shares are sold on behalf of all investors.
To qualify for EIS relief, companies must be small and at the start of their growth journey. So that means taking on the risk of smaller company investing. But if a company fails to perform, investors can benefit from loss relief. The net loss (amount invested less upfront income tax relief granted) can be claimed against income tax or capital gains tax. This is a significant benefit when making a high-risk investment.
A reminder of the key risks
The value of the investments discussed, and any income from them, can fall as well as rise. Investors may not get back the full amount they invest.
Tax treatment depends on individual circumstances and tax rules may change in the future. Tax relief depends on portfolio companies and VCTs maintaining their qualifying status. BPR qualification is assessed by HMRC on a case-by-case basis when an estate makes a claim.
VCT shares and the shares of smaller companies are by their nature high risk, their share price may be volatile and they may be hard to sell.
For those new to this kind of tax planning, getting to know the space is critical.
“Although the tax breaks are terrific, these are investments. And you’ve got to be comfortable with the investment and the team,” says Mike.
“Get to know it. Get excited about it. Get into it. You’ve got to understand what the investments are and meet the teams.”
VCTs and EIS investments are not suitable for everyone. Any recommendation should be based on a holistic review of your client’s financial situation, objectives and needs. We do not offer investment or tax advice. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: December 2020. CAM010543
What are the top skills employers typically want to see from a paraplanner? Lewis Byford, co-founder of financial services...
With £355 billion of debt having been accumulated in the past year and a potential £204 billion or more to be...
Are you signed up to the Professional Paraplanner daily website alert? For more technical, tax, pensions, investment, retirement, protection...