Making the UK tax system work for investors

The United Kingdom’s tax system is not progressive.

It taxes people in the middle higher than people at the top, and it taxes wealth less than income. If you receive dividends and interest, you pay less tax than you would if you were in a job.

Bizarrely, if you are in a job you pay up to 25% of your earnings in National Insurance (NI), but if you are rich and live off of the returns from your assets you largely avoid NI contributions.

That is why it is important to think about the tax system when investing your hard-won wealth.

For example, did you know that somebody whose spouse doesn’t work, and who earns between £50,000 and £64,000 a year, will be taxed at a marginal rate of 70% (see chart below), whereas those earning £11,000 and £150,000 are taxed at a marginal rate of 40%.

The UK tax system is also ageist, as savings and dividend income – which tends to be received by those in retirement – is taxed at 7.5% up to the first £42,000. You have to know how the tax system works in order to maximise its benefits for you.

Taxation of the rich has never been more topical

With the so-called Paradise Papers published in November – a leak of more than 13m documents from offshore law firms and registers, and Chancellor Philip Hammond’s changes to Enterprise Investment Schemes (EISs) – taxation of the rich has never been more topical.

The table below vividly illustrates how the UK tax system targets earners in the £43,000 to £60,000 tax brackets, along with those in the £100,000 to £122,000 brackets.

UK Marginal Personal Income Tax Rates
UK Marginal Personal Income Tax Rates

If you are a high earner who likes to invest in a tax-efficient manner, you will already have put the maximum allowable into an individual savings account (ISA) – £15,000 a year – and if you are able, taken advantage of the ability to put up to £40,000 a year into your pension, which is taxed at a marginal rate of 20%.

Further opportunities for minimising tax bills using aggressive tax saving schemes have greatly diminished in recent years as a result of government crack downs and clawbacks, forcing independent financial advisors to focus investors’ attention to the ever-decreasing number of legitimate tax-efficient vehicles that still retain the HM Revenue & Customs seal of approval.

Enterprise investment schemes are commanding investor attention

As a result, Enterprise Investment Schemes (EISs), which were launched more than two decades ago to encourage investment in the UK’s small and start-up enterprises, are commanding investors’ attention.

To compensate for the high risks associated with investing in small companies and start-ups, taxpayers are entitled to claim generous tax breaks. Investors are permitted to put up to £2 million into EIS qualifying investments a year and receive upfront tax relief, and again on exiting the investment after the expiry of a minimal period.

Income tax relief at 30% of the investment can be claimed by taxpayers when they make their initial investment, which can be “carried back” to offset income tax liabilities from the previous year. But in order to qualify for the income tax relief – and the deferral of capital gains tax on exit, investors must hold their shares for three years.

How EISs reduce investor risk in start-ups

The Taxman cometh - and he is far from fair.
The Taxman cometh – and he is far from fair.

Since the launch of EISs in the early 1990s, billions of pounds has been invested in UK small businesses and start-ups that would not have benefitted from the availability of such funding had it not have been for the HM Customs & Revenue initiative. HM Revenue & Customs backs EISs because it boosts businesses, and brings in more tax revenue over the medium to long-term.

The potential size of the EIS market in the UK is thought to be around one million, but only 25,000 have so far availed themselves of the opportunity as most financial advisers do not feel skilled enough to advise on the tax and capital gains relief that is available to those who qualify.

In his November 2017 budget statement Chancellor Philip Hammond announced that not only would he keep the generous tax breaks but he would also increase them for Knowledge Intensive Companies – where he doubled the investment limit for both the company (from £5 million per year to £10 million per year), and the individual where the limit was increased from £1 million to £2 million. Hammond did however say that he would be reviewing the eligibility of some of the lower risk investments – such as wine farms and conference venues.

Investors who have income tax liabilities such as PAYE, have paid capital gains tax in the last three years or inheritance taxes in the last two years, and are keen to get involved in a combination of asset-backed businesses and high potential start-ups before HMRC changes the rules, should contact the Aziza Coin UK Team to see if you are eligible (01483 286877).

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