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Income tax planning

Isas offer freedom from income tax and capital gains tax. In addition, the 10 per cent tax credit on dividends from UK equities can be reclaimed until April 5, 2004.

Investors have a choice of one of two types of Isa each tax year – a maxi Isa or mini Isa, the features of which are set out below. In one tax year, an investor cannot contribute to both. Investors will need to invest before April 6, 2002 if advantage is to be taken of the full Isa allowances for 2001/02.

– Maxi Isa

The maxi Isa is an Isa with one Isa manager. It has an annual subscription limit of £7,000 until April 5, 2006.

A maxi Isa must offer a stocks and shares component, with or without a cash and/or insurance component.

The limit on investment applies only to the cash component of £3,000 until April 5, 2006 and the insurance component of £1,000. To determine how much can be invested in the stocks and shares component, it is necessary to deduct from the annual subscription limit any amount subscribed to the cash and/or insurance component.

– Mini Isa

The three types of mini Isa are stocks and shares, cash and insurance. They can be taken with the same or different Isa managers.

Each type has an annual subscription limit – £3,000 for stocks and shares, £3,000 until April 5, 2006 for cash and £1,000 for insurance.

Subject to the overriding limit, an individual can have up to three types of mini Isa in a tax year.


A number of Tessas will be maturing before April 6, 2002. At maturity, capital put into a Tessa can be transferred within six months of maturity into the cash component of an Isa or a separate cash Isa, known as a Tessa-only Isa, without counting as an Isa subscription. This applies to all Tessas started before April 6, 1999 including roll-over Tessas.

Subscriptions to a Tessa which commenced before April 6, 1999 can be continued for the remainder of its five-year term.

Enterprise zone property

If property investment appeals and the investor is a higher-rate taxpayer, an investment in a property in an enterprise zone or a fund of such properties may be suitable. The Inland Revenue will give full income tax relief on such an investment. No upper maximum investment limit applies.

A pooled investment opportunity is available in the form of enterprise zone trusts where the investments of a number of investors are pooled to enable a suitable property to be purchased. As well as full income tax relief on the investment, the following advantages are available:-

Loans can be arranged to facilitate investment.

An income yield is available in the form of rental income.

Where borrowing takes place, interest paid can be offset against rental income from the property for tax purposes. The arrangement can sometimes be virtually self-financing because interest can be deducted from rental income in determining income from property assessable to tax.

It is important to remember that the investment must be maintained for at least seven or 25 years (depending on the precise nature of the scheme) for full income tax relief to be retained. It is also important to consider carefully the likely future capital value of the investment and its ability to produce rental income. This is particularly the case if money is borrowed to finance the investment. Fixed interest rates may give some additional security.

Enterprise investment schemes and venture capital trusts

– Enterprise investment schemes

The EIS offers tax relief on an investment in new shares of an unquoted trading company which satisfies certain conditions. For 2001/02, an investment of up to £150,000 can be made to secure income tax relief at up to 20 per cent. As the investment is in new shares of an unquoted trading company, the investment risks are regarded as greater than for ordinary collective investments. Certain Alternative Investment Market companies qualify as EIS companies.

Capital gains tax deferral relief is also available on EIS investments. The amount of deferral relief is unlimited provided some of the EIS investment potentially qualifies for income tax relief. If an investor disposed of any assets and this resulted in a taxable gain, payment of tax on such a gain can be deferred if reinvestment in an EIS takes place within three years of the disposal. For a higher-rate taxpayer, this relief, coupled with the income tax relief, will give a total initial tax relief of up to 60 per cent.

– Venture capital trusts

VCTs will also provide immediate income tax relief at up to 20 per cent for an investment in new shares, coupled with capital gains tax deferral relief (restricted to the lesser of the amount invested and £100,000 per tax year) if some income tax relief is obtained. However, in the case of a VCT investment, deferral relief is only available if an investment is made within 12 months of the date of the disposal. For a higher-rate taxpayer, this relief, coupled with the income tax relief, will give total initial tax relief of up to 60 per cent.

Life insurance

The most obvious and popular example of an insurance-based investment must be the single-premium bond. Apart from investment performance (which, of course, will depend on the funds chosen, charges, etc) the key tax benefit is its tax-deferment qualities.

Regardless of whether the bond is underwritten by a UK or non-UK life office, provided it is not a personal portfolio bond, it allows the investor control over the timing of the tax charge. Until a chargeable event occurs, no liability to tax can possibly arise. It should be remembered that, with a UK bond, a full basic-rate tax credit will be available for the policyholder on encashment even though, in most cases, the actual tax suffered in the life fund is less than the basic rate.

Also, there is no grossing up of the gain before applying the 18 per cent (40 per cent less 22 per cent) tax charge, where appropriate, to the gain. Where the effective rate of tax borne by the life fund is, say, 20 per cent, this means the effective rate borne by a higher-rate taxpayer on any gains made (taking account of tax at the life fund and personal level) is only 34.4 per cent.

It is worth noting that an assignment of a policy by way of gift is not a chargeable event and gains made after the assignment will in most cases be assessed on the assignee. This means unconditional outright gifts of policies to spouses or children over the age of majority (or gifts into trust for them with encashment deferred if necessary until the beneficiary achieves the age of majority) prior to encashment could result in a lower or nil tax rate applying to any gain made.


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