As another tax year draws to an end, (and what a year it has been for all the wrong reasons) it is time to turn your attention to some basic tax planning strategies that are often overlooked but maximise your allowances.
Our Head of Private Client Tax, Paul Webster, has provided his thoughts on a number of these that you may want to consider. Please reach out directly to Paul at email@example.com for an introductory conversation.
Utilising Spousal Rate Bands and Personal Allowance
If you are paying tax at the higher or additional rates and your spouse is paying tax at the basic rate, it may be sensible to pass assets over to them in order to reduce your own tax burden. There is, of course, no CGT or IHT on interspousal transfers.
If a donation is made to a charity registered for the gift aid scheme, your basic rate band is extended by the ‘grossed up’ amount of the gift. For example, if you contributed £1,000, your basic rate band is extended by £1,250, saving you £250 in tax if you are a 40% taxpayer and £312.50 if you are additional rate.
Should your total 2020/21 income be between £100,000 and £125,000, it will save you even more, as it will avoid clawback of some or all of your personal allowance depending on the amount you donate. Earnings between £100,000 and £125,000 are taxed at an effective rate of 60% because of the personal allowance clawback.
Tax Efficient Investments
It is sometimes worthwhile looking at investments in start-up businesses that have approval for Enterprise Investment Scheme (EIS), Seed Enterprise Investment Scheme (SEIS) or Venture Capital Trust (VCT) relief, as there are some extremely generous reliefs to be had.
EIS: The EIS is designed to encourage investment in small, growing businesses and can bring valuable tax advantages for investors.
Up to £1,000,000 may be invested in qualifying companies. The resulting 30% tax credit may be offset against your tax liability for the year in which the investment is made or related back to the prior year. You can also choose whether all or part of the relief can be related back. There are also other tax advantages including:
• After the minimum holding period (three years), the shares may be sold at a gain and no tax is chargeable.
• If you sold a chargeable asset and invested in EIS qualifying shares one year before or three years after the disposal of that asset, the capital gain can be deferred. The deferral is £1 of gain for £1 of investment. When the shares are eventually sold, the gain comes back into charge.
• Loss relief against other income.
SEIS: The Seed Enterprise Investment Scheme (SEIS) provides an opportunity to invest in high-growth, early-stage start-ups whilst providing investors with some of the most generous tax reliefs available, including income tax relief of up to 50%.
Up to £100,000 may be invested in qualifying companies. The resulting 50% tax credit may be offset against your tax liability for the year in which the investment is made or related back to the prior year. All or part of the relief can be related back.
Furthermore, you can exempt 50% of any chargeable gain made where you invest all or part of that gain in qualifying SEIS shares. For example, if you invested £75,000 in 2020/21 and in the same year you had a gain of £100,000, a total of £37,500 of that gain is exempt from tax.
As with EIS, if the shares are held for 3 years or more and relief was claimed on the initial investment, any gains will be exempt. Also, if shares are sold at a loss, it is possible to claim that loss against your income for the year in which the loss arose. If the election for income tax loss relief is not made, the default position is that the loss will be banked as a capital loss and is available to carry forward and be used against future capital gains.
VCT: A Venture Capital Trust invests in small companies that have high growth potential and offer investors the opportunity to invest in a diversified portfolio of small companies. Whilst VCT’s can bring higher risks than EIS or SEIS schemes, they can provide you with a 30% tax reduction on the amount invested up to a maximum £200,000 investment.
Dividends paid by VCTs are exempt (unlike EIS and SEIS) from tax and capital gains on these VCT investments will be exempt.
ISAs: Every UK resident individual over the age of 18 can invest up to £20,000 in a new ISA in 2020-21. Investments can be in a cash ISA and/or a stocks and shares ISA in any combination of amounts, provided that the overall annual limit is not exceeded. Any part of the annual investment limit unused during the tax year is lost. Income and gains arising within an ISA are free of income tax and CGT.
With pension relief and allowances constantly being changed by the government, it would be sensible to review whether you are able to make a contribution before the year end to use up your 2020/21 allowance and any allowance brought forward from the preceding 3 tax years.
If your income exceeds £240,000, your annual allowance is reduced by £1 for every £2 of income up to £312,000 (i.e. from £40,000 to £4,000). Consequently, if your income exceeds £312,000 each year, you only have £4,000 (£3,200 net) tax relievable pension contributions available to you.
You should note that both employer and employee contributions count towards your annual allowance. If the annual allowance for 2020/21 (including any brought forward) is exceeded, there will be clawback of all relief through Self-Assessment, including the 20% given by the government at source.
CGT Annual Exempt Amount
If you own shares or other chargeable assets, it is worth considering realising gains in order to utilise your annual exempt amount of £12,300 before the year end.
If you are a shareholder in a corporate vehicle and there are distributable profits available, you should always take advantage of voting a tax-free dividend of up to £2,000 per annum. That is unless there is good reason to retain profits in the business, for example to meet applicable regulatory capital requirements.
These are just a few simple measures that can be taken to easily reduce your exposure to tax. If you would like support with your personal tax situation, or would like to discuss these or any other tax issues, please contact our Head of Private Client Tax, Paul Webster at firstname.lastname@example.org