Stay-at-home tax havens
First published 16 June 2015 • Updated 23 January 2017
The dilemma: no business wants to pay more tax than it needs to. But no business wants to be accused of improper tax avoidance. Is there a safe path between these opposing hazards? Adrian Murphy, partner at Murphy Wealth, offers up some legitimate possibilities.
One of the most popular questions that business owners ask us is, how can they reduce their tax bill? This has been a particularly sensitive subject in recent years, with the government clamping down on artificial schemes which manufacture some kind of tax avoidance by taking a different interpretation of the law. This was always particularly risky and will no doubt be causing problems for many people for some time to come. What business owners are really asking, then, is: can we reduce our tax bill with no risk of it coming back to bite us later?
Thankfully, the answer is yes. There are still options available that are written into legislation, giving tax relief on certain types of investment. Because these investments help to drive the economy, it is a form of tax efficiency that the government actively encourages.
The trusty pension contribution
Pensions have always been tax efficient ways to save, but the new pension freedom means that a pension pot has become an even more attractive and versatile way to put money aside, for a whole host of different purposes, not just providing an income in retirement.
There are of course certain limits on the pension contributions you can make. Specifically, you can only contribute 100% of your income up to a maximum of £40,000 per year. However, one thing in your favour is the carry-forward rules, which allow you to contribute any unused annual allowance from the last three years. Again, there are certain rules governing this too as you might expect; but generally speaking there is the potential to make a contribution of £190,000 with up to 45% income tax relief.
As a business owner, particularly if you take your income in dividends, it may be more efficient to make an employer contribution to your pension, which would reduce your corporation tax bill.
EIS and VCT both mean less T-A-X
If you have exhausted your options with your pension, there are still more to explore. For instance, you may wish to consider an Enterprise Investment Scheme (EIS) or a Venture Capital Trust (VCT). These are strictly for high net worth investors, which I’ll define here as at least £100,000 of liquid assets plus income, or liquid assets of £250,000 and upwards.
A note of caution: these types of investments have received some bad press over the years for investors losing their money. Nevertheless, there are some good quality options available in the marketplace today. It’s the job of your financial adviser to carry out the necessary research and due diligence to understand the investments and the risk to which you’ll be exposed.
Both EISs and VCTs invest mainly in unlisted companies and those listed on AIM (the Alternative Investment Market). As an investor in an EIS you receive the following benefits:
- 30% income tax relief on investments up to £1m per year
- A three-year qualifying period for tax relief
- Carry-back available to the previous tax year
- Tax-free gains
- Capital gains tax deferral available (such as on the sale of a business or second property etc.)
So what about the other option, the VCT? These offer different levels of risk, depending on your objectives. Naturally, the benefits are also slightly different:
- 30% income tax relief on investments up to £200,000 per year
- A five-year qualifying period for tax relief
- Tax-free income and gains
- Immediate tax relief available in the current tax year.
How to pick the right path
As you can see, on the face of it each of these options could potentially be attractive for a business owner looking to extract profit from their business in a tax efficient manner. Nevertheless, you shouldn’t just dive straight in. None of these options should be taken lightly (even the pension contribution option could have unforeseen consequences depending on your circumstance), so seeking advice is paramount. You should choose an adviser who has specific experience in these markets, and who knows how to address the needs of business owners in particular.
Adrian Murphy is a partner at Murphy Wealth. He advises clients on all aspects of wealth management including pensions, investments and tax planning. He particularly enjoys working with business owners and entrepreneurs, helping them protect their assets, make the most of their profits and ultimately plan their exit.