End of year allowances and tax

The present tax year will end on 5 April 2011, so now is a good time to consider the various allowances and reliefs you can take advantage of before the tax year comes to a close.

[caption id="attachment_1441" align="alignleft" width="492" caption="The present tax year will end on 5 April 2011"][/caption] If you are concerned about arranging your financial affairs tax efficiently or income in retirement, then this article will provide you with a general summary of the main personal tax planning opportunities.

ISAs – Individual Savings Accounts

An ISA is a tax-free savings wrapper that can be used to invest in a wide range of assets, from cash through to more exotic emerging market, ethical or environmental funds and other equity-backed investments. In this tax year the annual ISA allowance is £10,200 of which a maximum of £5,100 is permitted in a cash ISA. It is not possible to carry over previous year ISA allowances. One of the major benefits of ISAs is that assets held within them are exempt from capital gains tax. This, coupled with the fact that income can be drawn from an ISA free from tax, makes the annual ISA allowance very useful for making longer-term investments where there is reasonable expectation of good capital growth.

Thematic ISA investment – taking the long-term view

When planning your ISA investments it makes sense to consider investment assets which have the potential to make good capital gains over a 5–10+ year period. One example of this is the WHEB Asset Management Sustainability Fund, which invests across three core ‘themes’:

• renewable or non-carbon based energy sources
• water infrastructure
• demographic trends in the US and Western Europe: healthcare products and services

These three themes were selected as they represent very significant macro-economic trends only now beginning to emerge. For more information on ISAs, see our free financial guide to ISAs and tax free investments.

Maximising pension contributions

A pension scheme is far less accessible than an ISA as the benefits are only available from age 55. However the tax benefits on a pension payment are considerable. For higher earners with relevant incomes above £130,000, there are special rules in place to limit payments to a pension. But for everyone else the rules remain quite flexible and allow for very considerable payments and full income tax relief on the payment at either 20% or 40%. For example, a basic rate taxpayer making a single contribution of £10,000 into a UK registered pension scheme will see the value of the payment increase by £2,500 to £12,500. For higher rate (40%) tax payers the benefits are even better, as the rate of relief increases to 40%. If you are running your own businesses you should also consider employer pension payments as these are treated as a ’business qualifying expense‘, so are free from tax and national insurance. For those with earnings above £100,000, a pension contribution can be especially valuable as the effect of the payment is to reduce taxable earnings, therefore restoring part of the tax-free personal allowance.

Generating capital gains rather than income

The rate of tax on income is significantly higher than the tax due on capital gains and the personal allowance for tax free capital gains is much more generous at £10,100 per annum.  For this reason there are a number of investment vehicles which prioritise capital gains/growth over generating an income. For those that pay tax on their incomes at 40%, or even 50%, this can be very useful. If you have investments which have grown well, then now might be a good time to review the level of gains and consider switches to make use of the exempt allowance.

Enterprise Investment Schemes (EIS)

The Enterprise Investment Scheme (EIS) is intended to provide an incentive for equity investments into smaller higher-risk trading companies. The reliefs allow minority investors to secure a 20% income tax relief in addition to capital gains tax deferral relief. Income tax relief is forfeited if there is a disposal within three years. EIS reliefs are complex, so individuals considering an investment should always consult a suitably qualified and experienced adviser.

Venture Capital Trusts (VCTs)

VCTs are unregulated collective investment vehicles that are similar in structure to investment trusts and are quoted on the London Stock Exchange. They aim to encourage investors to back smaller unquoted companies, by offering investors a series of tax benefits:

• upfront income tax relief of 30% (on up to £200,000 invested in the first tax year providing the shares are retained for five years)
• tax-free dividends
• tax-free capital gains (when you sell your shares)

As with an EIS, investment VCTs are complex and can be very high risk, but as part of a carefully structured investment strategy they may well have a role to play. For more information on VCTs, see our free financial guide to ISAs and tax free investments.