MHA Guide to Tax Efficient Investments

With tax thresholds frozen until at least April 2028, a policy move often referred to as the “fiscal drag”, the importance of tax efficient investing has never been more pronounced. As inflation and rising incomes push more individuals into higher tax brackets without any adjustment to thresholds, the hidden cost of inaction grows steadily.

The direction of travel with tax makes it essential for investors to seek strategies that minimise liabilities while maximising returns. In this shifting economic landscape, understanding and leveraging tax efficient investments as part of your financial plan can provide a critical edge, ensuring your hard-earned money works harder for you in the years ahead.

Please find several tax efficient investments summarised below:

Individual Savings Accounts (ISAs)

ISAs are tax wrappers within which a wide range of savings and investment products can be held, free of UK income and capital gains tax by anyone aged 18 or over (16 or over for cash ISAs).

They serve as a ‘wrapper’ to fully protect savings from tax, allowing individuals to shelter up to £20,000 each tax year in a range of savings and investments and pay no personal tax on the growth and income received.

The annual ISA allowance can be utilised via stocks and shares, cash or innovative finance ISAs.

Stocks and shares ISAs are in the form of either individual shares, or pooled investments such as open- ended investment funds, investment trusts or life assurance investments.

Cash ISAs are usually contained in a bank or building society savings account. By giving up access to the monies you can fix the interest payable for a period, potentially achieving higher rates of return.

Innovative Finance ISAs are in the form of loans made through peer-to-peer platforms or companies via crowdfunding websites.

You must save or invest in your ISAs by 5^th April for it to count for that tax year and if you don’t use the allowance, it is lost. You will also be able to transfer money saved in previous years' ISAs without affecting your current year's annual allowance.

Pensions

Please refer to Charlotte Elgar’s article which breaks down the pension types, tax benefits and various points to consider when looking at pensions: MHA | The Power of Pensions

Offshore Bonds

An offshore bond is a tax-efficient investment wrapper, set up by a life insurance company that is resident in a jurisdiction with a favourable tax regime.

Care should be taken when offshore bonds are first established and at redemption as the structure cannot generally be changed once the plan is created and significant tax liabilities can be triggered on exit.

Similar to ISAs and defined contribution pensions, the amount payable on redemption of the offshore bond is linked to the amount invested and the performance of the underlying assets. Individuals can invest over the medium to long term in different types of assets, including equities, fixed interest securities, property and cash deposits

Whilst the investments remain inside the offshore bond tax wrapper, they will not be subject to Income Tax or Capital Gains Tax (CGT). This is referred to as ‘gross roll up’ and provides the potential for an offshore bond to grow faster than onshore UK bonds or directly held investments thanks to the compounding effect of the deferred tax treatment.

You can therefore switch between different funds within the offshore bond without giving rise to taxable gains unlike directly held investments.

It should be noted that offshore bonds are generally more expensive than other tax wrappers but generally offer greater planning opportunities as a wide range of trusts can be utilised, which offer varying degrees of protection, control, inheritance tax savings and access to the underlying capital.

Venture Capital Trusts (VCTs)

Venture Capital Trusts (VCTs) are specialist tax-incentivised investments that enable individuals to invest indirectly in a range of small higher-risk trading companies and securities. VCTs are companies in their own right and, like investment trusts, their shares trade on the London Stock Exchange.

Shares in qualifying VCTs offer the following tax incentives:

Upfront income tax relief at 30% of the amount subscribed, subject to a maximum investment of £200,000 per tax year. The investment must be held for a minimum of five years in order to retain the income tax relief. Note that income tax relief on the purchase of VCTs is available only where new shares are subscribed, and not for shares acquired from another shareholder.

Dividends received on VCT shares are exempt from income tax in respect of shares acquired within the ‘permitted maximum’ (including shares acquired from another holder).

Gains are exempt from Capital Gains Tax (CGT) and losses are not allowable on the disposal of VCT shares (including shares acquired from another holder).

Enterprise Investment Schemes (EISs)

Tax relief is available where you subscribe for shares qualifying for relief under the Enterprise Investment Scheme (EIS).

Under the EIS, your Income Tax liability for the tax year in which you make your investment, or the previous tax year, may be reduced by up to 30% of the sum invested. You can invest up to £1m under the EIS in a tax year or up to £2m if you invest at least £1m in knowledge-intensive companies (broadly these are early-stage businesses engaged in scientific or technological innovation).

If you sell your EIS shares at a profit after three years and the Income Tax relief claimed when they were acquired is not withdrawn, there is a Capital Gains Tax (CGT) exemption on the disposal of the EIS shares.

Losses on EIS shares (restricted by Income Tax relief given and not withdrawn) can be offset against gains or, alternatively, against general income in the tax year of disposal or the preceding year.

Inheritance Tax relief (via Business Relief) should be available for EIS shares provided they are held for two years.

In addition, capital gains arising on disposals of other assets may be deferred by reinvesting those gains in a subscription for qualifying EIS shares. The investment in EIS shares must be made in the period beginning one year before and ending three years after the disposal.

Prudent utilisation of the reliefs associated with tax-favoured investments as part of a balanced portfolio can make a big difference to future investment returns, but it is important to consider the risks associated with them and it is essential that professional advice is sought.

Family Investment Companies (FICs)

FICs can be a useful way to protect family wealth across generations, but the most appropriate structure will depend on the family’s circumstances and objectives.

A FIC enables parents and grandparents to retain control over assets whilst also protecting and enhancing wealth in a tax-efficient manner.  Care should be taken with the structuring and funding of a FIC to ensure that the directors can invest tax efficiently and ensure future growth is protected.

Profits and gains made by a FIC will be subject to corporation tax at 25%, where these exceed £250,000.  A lower rate of 19% will apply where profits are not more than £50,000.  Therefore, in many cases, this will still be lower than if the investments had been held directly or via trust, and suffered income tax at 40%/45%, and capital gains tax at a maximum of 24%.

If the company receives UK dividend income from investments in shares, this will be exempt from tax. However, other income, such as bank interest or rents from investment properties, will be taxable. Losses from a FIC’s rental business can be offset against other income in the company.

A FIC should be considered for long-term asset protection planning, as well in terms of the income needs of the family. Shareholders only pay tax personally when the FIC distributes income, or if it is wound up. There is merit in using a FIC to allow profits to be retained in the company until required and drawn when the individual’s personal tax rate may be lower.

Any investment gains and income could be paid into a pension plan for the benefit of the shareholders; therefore, it is recommended that parties to a FIC receive independent financial advice.

If you are seeking to preserve family wealth within a controlled family environment and/or wish to consider introducing the next generation into the decision-making about investments, please speak to a member of the MHA tax team about how a FIC could benefit you.