Derek came to us with an interesting problem at the end of the last tax year.
He had invested in a property investment syndicate and the property had then been sold, resulting in a substantial capital gain. He was keen to do something about this if possible.
At the same time, the investment had thrown up a large income loss, which cannot be set against the capital gain. Part of this was through the writing down allowances available from the property and part from various penalties and charges arising on the redemption of the loans on the property. HM Revenue & Customs had said these could not be set against the gain – which is debateable.
Rental losses can only be set against rental income and it may be that the client will not have rental income in the future. Certainly, it would take some time to offset the level of losses. It therefore made sense to take advantage of the ability to carry the writing down allowances sideways against other income in the year.
Sadly, Derek did not have enough income so the first bit of the exercise was to create income by selling various offshore funds that would generate income gains.
On the capital gains front, it was decided to invest in an enterprise investment scheme that had been put to him that was particularly interesting as an investment opportunity. There were two decisions to make. How much offshore investment should be sold to create income and how much should be invested in the EIS to maximise relief but without being too risky?
Looking at the previous year’s figures, we were able to get a pretty good picture of his pensions and interest. We were then able to calculate how much should be sold to raise the required income, against which we would set the writing down allowances. This brought the income down to the right level so as not to lose personal allowances.
But we needed to factor in the capital gains tax. The first problem here was that the gain was so large that we decided to limit the chargeable gain to basic-rate tax. It was simply unfeasible to defer the full gain and the investment risk of the EIS did not make it worthwhile.
There are two tax elements to EIS investment – deferral of the capital gain and income tax relief. One important feature of the deferral rules is that EIS relief is given before taper relief, so we had to start with the gross gain. This was made just that little bit more difficult because some of the gain was a business asset so the taper rates were different.
Taking the various rates of tax and exemptions into account, we calculated the amount of untapered gain that we would want to shelter and thereby the amount to invest in the EIS.
However, there was also the income tax relief to be considered at 20 per cent of the investment. The problem was that EIS relief is a deduction against the tax payable rather than being a charge against income.
Having already reduced the taxable income to zero, there was no scope for relief. We could have created more income to soak up the EIS relief but that would have meant more of the capital gain (that we had brought below the higher-rate threshold) getting taxed at 40 per cent. The situation would be that Derek could have deferred some of the gains but lost out on income tax relief – clearly not ideal.
But there was one last opportunity. EIS investments can be made up to three years after the date of disposal to allow for deferral of capital gain. So Derek could hold off the EIS investment until after April 5. He would still be able to defer the gain and take advantage of the income tax relief.
We did not know what income he would have next year but at worst we could create more income gain by selling further offshore funds, in which there is a fair amount of profit. We knew that the EIS investment remained open for some time so there was that flexibility.
Mark Bolland is a director at Chamberlain de Broe