10 May 2011 | Capital Hill

Capital Hill on... Tax-Efficient Investing 

Tax doesn’t have to be taxing, or so HM Revenue & Customs
would have it. For most of us mere mortals the system is
mind-numbingly complex, writes Jennifer Hill.

Even someone such as me, who has written for the media on how consumers can legitimately beat the taxman for more than a decade, can find it bewildering.

As I discovered when hiring a new accountant, it can also prove perplexing for professionals: I met with five of these number-crunchers recently, most of whom had different ideas on how to structure my company’s affairs in the most tax-efficient way, and what was – and was not – allowed under current legislation.  

Thankfully, it’s not all smoke and mirrors and, despite the perilous state of the country’s finances, the recent Budget brought some good news for those looking to invest tax-efficiently in the nation’s fledgling companies.  

With the onset of a new tax year on 6 April, there have also been changes to the rules governing how much you can stash into your pension pot and individual savings account (ISA).  

So, what can you do? Well, one of few surprises in March’s Budget was a significant boost to the Enterprise Investment Scheme (EIS), which enables investors to tap into the fortunes of start-up and early-stage companies. Tax relief was increased from 20% to 30% on 6 April, bringing the EIS into line with Venture Capital Trusts (VCTs), another way in which investors can back small British businesses.  

The amount that attracts upfront tax relief and be sheltered in an EIS will double to £1 million from April 2012 – giving a maximum income tax saving of £300,000. The Treasury estimates this will cost £450 million in lost tax revenue. The most that can be invested into VCTs will remain at £200,000 a year, giving another potential £60,000 in tax relief.  

Of course, few of us have £1.2 million a year to spare. Moreover, many small businesses hit the buffers within their first year of trading, so these schemes aren’t for the faint-hearted.

Another way to keep your cash out of the taxman’s coffers is to use your ISA allowance. It’s a ‘use it or lose it allowance’ – so you can’t carry it forward into subsequent tax years. It’s consistently failed to keep pace with inflation, but Chancellor George Osborne appeased consumer groups last summer when he said the limit would be increased at the start of each tax year by the rate of inflation the previous September.  

Last September, the Retail Prices Index rose by 4.6%, which would have given a new allowance of £10,669.20 (up from £10,200). However, the Treasury said the figure should be easily divisible by 12, given that many people have monthly savings plans, and set a new limit of £10,680 for 2011-12. 

Up to half of the annual limit, so £5,340 this tax year, can go into a cash ISA and the rest into stocks and shares. Alternatively, you can put the whole sum into an stocks and shares ISA.
Pension contributions are also highly tax-efficient, giving retirement savers tax relief at their highest marginal rate of income tax.  

After A-Day on 6 April 2006 – when so-called ‘pensions simplification’ came into force – people were allowed to pay 100% of their earnings into their pension subject to an annual allowance (set at £215,000 and rising to £255,000 in 2010-11).  

Many people held off from contributing in the hope of squirreling large sums into their pensions in their final years of work, but the Labour government scuppered that plan. From April 2009, anyone earning more than £130,000 who had a history of irregular pension contributions was able to contribute just £20,000 a year with tax relief.  

Two years on, and the rules have changed again, courtesy of the coalition. From 6 April, this ‘special annual allowance’ was abolished in favour of a reduced limit for everyone of £50,000.  

You’re able to carry forward three years-worth of unused annual allowances at £50,000. So, say you’ve only been able to pay in £20,000 in each of the past two years. Under the new regime, you would be deemed to have unused allowances of £30,000 in both those years – meaning you could contribute £60,000 plus £50,000 (for the 2011-12 tax year) this year, giving a total potential contribution of £110,000.  

If you’ve been dissuaded from contributing to your pension at all recently, you could salt away a whopping £250,000, with full tax relief, into your pension over the course of a year (from 6 April 2011 to 6 April 2012). This would comprise £50,000 (the annual allowance for 2011-12) plus £150,000 (carry forward of unused allowance from previous three years) plus £50,000 (the annual allowance for 2012-13).  

Who knows how long it will be before the government changes the rules again? It’s wholly conceivable – if not rather likely – that tax relief could be limited further in the future, especially for higher earners, so it may be wise to make use of it while you can.

Please remember that the value of your investment and any income from it is not guaranteed and may go down as well as up, you may not get back the amount originally invested.

Current tax rates and reliefs and the tax treatment of ISAs may change. The value of any tax benefits will depend on investors' individual circumstances

Author: Jennifer Hill
Jennifer is an award-winning British financial journalist. She recently left The Sunday Times, where she was deputy Money editor, to set up her own company, mediahill Ltd. She is a previous personal finance correspondent of Reuters, the global news service, and personal finance editor of The Scotsman newspaper.

She has won or been shortlisted for six Headlinemoney awards, the ‘Oscars’ of personal finance journalism in the UK. She has also scooped or been nominated for accolades from the Association of Investment Companies, Ignis Asset Management, the Association of British Insurers and the British Insurance Brokers’ Association.