Most are looking for something in between, and to aid this one of the strategies employed is investing in a tax efficient way into high growth SMEs.
This approach allows an investor to support the next generation of exciting, British businesses while mitigating some of the risk through the use of tax efficient incentives and reliefs. This also allows for a greater upside benefit, particularly when the return is compared to the net investment outlay.
There are a number of ways that investors can invest tax efficiently, each with their own focus and benefits, giving investors the ability to choose an approach that best suits their priorities and personal circumstances.
And on the highest of levels, these investment choices can be divided into five main ways.
1. Individual Savings Accounts (ISA’s)
Individual Savings Accounts, or ISA’s, will almost certainly be the most widely recognised investment method on this list. Capital invested into an ISA is allowed to grow in a tax-free environment, meaning that any income, be that interest for Cash ISA’s or dividends or capital growth for S&S ISA’s will be exempt from the respective taxes.
The next – hopefully – well known way to invest in a tax efficient way is through pensions. Pension contributions up to the annual allowance of £40,000 – or 100% of your income if lower – can be made with tax relief at your prevailing rate of income tax. This allowance is tapered for high income individuals. An individual is a high income individual where ‘threshold income’ exceeds £110,000 and ‘adjusted income’ exceeds £150,000. The annual allowance is reduced by £1 for every £2 of adjusted income in excess of £150,000 but cannot be reduced below £10,000.
‘Threshold income’ is your net income less gross personal pension contributions.
‘Adjusted income’ is net income plus occupational pension contributions plus employer contributions.
Your pension pot is allowed to grow in a tax-free environment, so as with ISA’s, once you have paid into a pension scheme this amount can be invested into allowable assets, which can provide an income or growth without needing to pay tax.
Self-Invested Personal Pensions (SIPPs) and Small Self-Administered Schemes (SSASs) are pension wrappers designed for business owners that that are controlled by the scheme beneficiaries and allow the members to invest into a wide variety of assets to achieve growth in their investment.
3. Enterprise Investment Scheme (EIS)
This offers investors the ability to back unlisted businesses, which generally represent higher risk due to their early stage and lack of liquidity. This is offset by a raft of tax reliefs, including the headline income tax relief of 30% on the value of your investment, as well as capital gains deferral on invested gains and exemption on growth achieved. To further mitigate the risk, EIS shares are eligible for loss relief on the net invested amount if the investment doesn’t produce a return, potentially reducing the total exposure to 38.5%.
4. Seed Enterprise Investment Scheme (SEIS)
The younger sibling of the EIS, SEIS was launched in 2012 to cater for the earliest of all businesses seeking investment. This scheme provides support for the first £150,000 of external equity capital a business raises within its first two years of trading. By October 2017, SEIS had helped 6,665 companies raise over £621 million of investment and provides attractive incentives to investors for investing into these earliest stage businesses.
Representing this highest level of risk for investors, the SEIS tax reliefs are similar to, but greater than, those of EIS, with 50% income tax relief upfront and reinvestment relief that allows investors to reclaim 50% relief on a reinvested gain. These, along with the similar capital gains exemption on disposal and loss relief, ensure a potential total exposure as low as 13.5%. However, it should be stressed that these are the earliest of the early businesses and are therefore the riskiest, with limited liquidity and a potentially long wait to an exit, if any.
5. Venture Capital Trusts
More of a cousin than sibling to the enterprise schemes, VCT’s take a slightly different structure for investment and allow a wider range of companies, though the reliefs can be similar to the two schemes.