My last article Venture Capital Trusts and Enterprise Investment Schemes – a risk worth taking? looked at the nature and structure of these investment mediums, the risks involved, and also touched on the tax benefits provided. Now, I will look in greater detail at the tax rules surrounding both.
Venture Capital Trusts (VCTs)
The greatest interest to most investors in VCTs is income tax relief at 30%. This is available to be set against any income tax liability that is due, whether at the lower, basic, higher or additional rate. In a tax year for which shares (to a maximum of £200,000) are bought, the shares themselves must be ordinary shares and must not carry any preferential rights, or rights to redemption, at any time in the period of five years beginning with their date of issue.
Relief is claimed through the tax return for the year in which the shares are issued, although it is not necessary to wait for the submission of the tax return to get the benefit of the relief. For example, if the investor pays tax under PAYE and wants to get the relief immediately, it is possible to request an adjustment to the investor’s tax code. If the investor is due to make a self-assessment payment on account he or she, subject to certain conditions, can make a claim to reduce these.
However, irrespective of how relief is claimed the amount cannot exceed the investor’s income tax liability for that year. For example, if the investor subscribes for £100,000 worth of shares in the current tax year (2013 / 2014) the maximum tax relief would be £30,000. If the investor’s income tax liability in that year (before any income tax relief is obtained from the VCT) is a total of £25,000 that is the relief that will be received. The difference of £5,000 cannot be set against income tax liabilities of any other tax year.
There are two other points worthy of note in respect of income tax relief. First, any dividends paid are exempt from income tax. Secondly, if the investor sells the shares within five years of them being issued (which does not include transfers between spouses or death of the investor) HMRC will require the investor to repay some, or all, of the relief, received. The amount repaid will be the smaller of:
• The amount of the relief for the shares disposed of, and
• 30% of the amount received for the shares that were disposed
Finally, VCTs are exempt from capital gains tax (CGT). Specifically, there will be no chargeable gain, or indeed an allowable loss, for CGT purposes on selling VCT shares provided the shares were acquired within the permitted maximum for the tax year in question.
Enterprise Investment Schemes (EISs)
As with VCTs income tax relief is available to investors who purchase shares in an EIS at 30%. Relief can be claimed up to a maximum of £1,000,000 giving a maximum tax reduction of £300,000 provided sufficient income tax liabilities exist to cover it.
Perhaps more importantly, unlike with a VCT where the relief applies to the tax year of investment only, EISs provide a carryback facility which allows the investment or part of the investment in one tax year to be treated as though it was used to acquire shares in a preceding tax year. Shares must, however, must be held for three years (instead of the required five with a VCT) from the date shares were issued, or the date the qualifying trade started if this is later otherwise income tax relief will be withdrawn.
It is important to note that investors cannot claim tax relief from HMRC until the EIS provider has issued an EIS3 certificate. On a practical level, it is important for cash flow purposes to understand that this can take anything from five months to a year and sometimes longer from the date of the investment.
Whilst, unlike VCTs, dividends are not exempt from income tax, EIS investments are eligible for loss relief which can be considerably more valuable to the investor. Any shares disposed of at a loss means the investor can elect for that amount of loss, less any income tax relief received to be set against his or her income or capital gains.
For example, a £10,000 investment with £3,000 income tax relief that results in a total loss will provide the investor with a £7,000 income tax loss. To a 45% taxpayer, this would be worth a further £3,150 worth of relief. To put it another way, the downside for an additional rate taxpayer of an investment into an EIS is a maximum loss of 38.5% of his or her capital.
Turning to CGT, provided the investor receives income tax relief which is not subsequently withdrawn, any gain will be free from CGT after three years from the date of the issue of the EIS3 certificate.
Arguably of greater value, an EIS investment also provides CGT deferral relief from any gains arising on the disposal of other assets. The EIS shares subscribed for must be issued to the investor in the period beginning 12 months before and ending 36 months after the date of the disposal for which the investor wishes to claim relief.
This is best illustrated through an example:
An individual disposes of an investment property valued at £200,000 producing a chargeable gain of £30,000 on 10 June 2013. In order to defer any CGT liability, the investor must make a subscription for EIS shares of at least £30,000 where the shares are issued between 10 June 2012, and 10 June 2016.
It should be noted, however, that the whole, or part, of the deferred gain, will become assessable when the EIS shares are disposed of at the individuals prevailing CGT rate at that point unless the investor dies before the chargeable event occurs, or he or she invests in a further EIS and continues to claim deferral relief on the new EIS investment.
Finally, by investing in EIS shares it is also possible to benefit from business property relief (BPR). BPR provides an exemption from UK inheritance tax (IHT). There is a minimum period of ownership that applies for an investment in order to qualify for BPR, which in most cases is two years immediately preceding an event where IHT would become chargeable; such as a gift to a discretionary trust or death.
As this series of articles continues I will illustrate using case studies how investors, in a variety of different circumstances, can use these now mainstream tax-advantaged investments as an integral part of their investment portfolio.
How does equity release affect tax?
Equity Release is exempt from Income Tax as it’s not a form of income; it’s a loan, just like a residential mortgage. Even if you are planning to use Equity Release to top up your income, you are not subject to any taxation.