Insights

4 ways to make the most of your income – tax free

By Lesley Stalker on 25 June 2014

This blog outlines some ways in which you can reduce your personal tax liabilities using Government approved initiatives like EIS, Gift Aid and others. Using these initiatives will not attract unwanted attention from HMRC but with any investment, it is important to seek professional advice before making a commitment.

1. It’s a nice time to open a NISA

Next month marks the start of new higher limits on investments cash ISAs. For the current tax year, starting on 1^st July, taxpayers will be able to invest up to £15,000 in a New ISA (NISA) and will no longer have to split the amount invested between shares and cash, although a mixture can be invested if preferred. The NISA therefore marks a significant change from the old rules, under which £11,520 could be invested with a cash limit of £5.760. If you have already opened an ISA this tax year (after 6^th April 2014) it will automatically become a NISA from 1^st July and will have the £15,000 annual limit.

Income and gains are tax free within a NISA so these investments are especially attractive to higher rate taxpayers and those who are already utilising their annual capital gains tax exemption elsewhere.

From 1^st July, the NISA rules are as follows:

You are able to invest £15,000 in cash only.
You are able to invest £15,000 into a stocks and shares NISA.
You are able to invest a combination of amounts up to a total of £15,000 into a NISA.
Transfers to and from cash to stocks and shares can be made within a NISA whereas the old ISAs only allowed investors to transfer a cash ISA into stocks and shares, but not vice versa.
Junior ISAs have also been extended and the limit will become £4,000 from 1^st July.
It is still only possible to have one NISA per year, but you are able to transfer old ISAs into new NISAs.

NISAs provide a much more flexible solution for savers; there is just one nagging issue; interest rates are at an all time low!

2. Double jackpot for investors in Premium Bonds

Starting this month, the maximum amount an individual can invest in Premium Bonds is £40,000 and the level is set to further increase to £50,000 in the next year or so. The Government has also said that there will be more winners of £1million, with 2 winners being announced each month from August 2014 instead of just the one as is currently the case. However the total value of the prize fund, which is £50million, will not be changing.

Premium Bond prizes are tax free and therefore especially attractive if you are a lucky winner!

3. Win-win for charities and taxpayers using Gift Aid

Gift Aid enables a higher or additional rate taxpayer to obtain personal tax relief whilst simultaneously helping a charity to maximise the value of donations it receives. This is because it is possible for the taxpayer to claim tax relief of either 20 or 25% on donations made (the difference between the 40/45% income tax rates and the basic 20% rate). So if £100 is donated, the 'grossed up' donation is £125 for the charity and a donor paying the 40% tax rate can claim tax relief of £25; i.e. 20% of £125.

Gift Aid primarily applies to gifts of money rather than goods or services; financial donations made by a company do not qualify for Gift Aid and donations of prizes, for example for a raffle, are also excluded.

4. Get income tax relief, CGT exemption, CGT deferral AND potential loss relief with EIS

Provided you fully understand the potential risks and have sufficient tax liability, the EIS (Enterprise Investment Scheme) is a very tax efficient way to invest additional income. An investment attracts income tax relief at the rate of 30%, so if an individual invests the annual maximum of £1,000,000 into an EIS approved company, they can reduce their tax liability by £300,000.

The tax relief is available provided the company involved has been approved for EIS and investors meet the qualifying conditions. These include holding the EIS shares for a minimum of 3 years, not being connected with the company either as an employee or by holding more than a 30% stake.

In addition to income tax relief, EIS shares are free from capital gains tax provided they meet the qualifying criteria; and for taxpayers with an existing capital gain, the liability can be deferred by investing the proceeds into shares in an EIS approved company. For example, if you own a second property and sell it at a profit, the proceeds can be invested within certain time limits into an EIS company and a claim made for the gain to be effectively ‘parked’ until the EIS shares are disposed of.

Conversely, where EIS shares become loss making, the loss (less any income tax relief obtained) can be offset against income to reduce future income tax liabilities.

What are the restrictions to obtaining tax relief through EIS?

The main restriction relates to investors with a connection to the company, either because they are employed, or because they have more than 30% of either the company’s share capital or voting rights. Individuals who are connected with the company as directors, but do not receive any remuneration, for example business angels, are not excluded from EIS tax relief.

Worked example - How does EIS work in practice?

Susie is a 45% tax payer and invests £10,000 in a qualifying EIS company. She holds the shares for 3 years to be eligible for income tax relief. Below are three scenarios to illustrate how she gains or loses on her investment, depending on company performance.

Scenario 1 – Investment yields a gain

Initial investment = £10,000

Income Tax relief @ 30% = £3,000 (reduction to personal tax liability)

Disposal yield = £15,000

Capital Gains Tax = £Zero

Total profit = £8,000 (£5,000 profit on disposal plus £3,000 income tax relief)

Scenario 2 – Investment value stays the same

Investment = £10,000

Income Tax relief = £3,000

Disposal yield = £10,000 – shares do not rise in value

Total profit = £3,000 (from the income tax relief)

Scenario 3 - Company closes after the 3 year qualifying period and shares become worthless