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Mitigating circumstances

In the last tax year, alongside income tax bills, £5.3bn was paid in capital gains tax and £3.8bn in inheritance tax.

Tax-efficient products such as venture capital trusts and enterprise investment schemes are needed more than ever in the present economic climate.

In particular, VCTs can be combined to great effect with Isas and Sipps to create strong financial planning solutions.

With many clients finding that the value of their pension investment has fallen, the VCT to Sipp approach offers a way of filling the hole in their pension. Clients can move an entire VCT into a Sipp after the required five-year holding period.

In doing so, they can take advantage of Sipp tax benefits, including a 25 per cent Government gross-up of investment post-tax and additional tax relief of 25 per cent of the post-tax investment, so the value of their overall investment increases by 50 per cent.

This is assuming there has been no growth in the VCT over the five-year period. Any growth in the VCT would, of course, mean the investment base would be higher.

For VCT investors wanting to begin their financial planning before the five-year period is up, the 30 per cent VCT tax rebate that VCTs provide can also be invested into a Sipp as an individual amount.

With investable assets increased by 30 per cent, there is more for clients and advisers to work with. Here, a 50 per cent Sipp increase on the 30 per cent tax rebate means an investment base of 145 per cent.

Alternatively, clients can invest the 30 per cent tax rebate into an Isa. A maximum of £7,200 can be held in an Isa for one tax year, so an investment of £24,000 in a VCT means the full Isa allowance is used (that is, £24,000 invested in a VCT will produce a 30 per cent tax rebate of £7,200).

Putting a 30 per cent tax rebate into an Isa also provides a tax-efficient haven for this sum, again ensuring that clients can extend the potential of their VCT tax benefit.

Alongside the potential for long-term returns from smaller company investment and the 30 per cent tax rebate, VCTs offer the potential for tax-free capital gains and tax-free dividends.

Enterprise investment schemes allow clients to enjoy a range of tax benefits alongside the potential for capital growth. The benefits include CGT deferral, 20 per cent income tax relief, inheritance tax exemption and tax-free capital growth.

The 20 per cent income tax rebate is a lesser-known feature but a major selling point of these schemes. This 20 per cent relief alone generates a post-tax return for investors of 7.5 per cent a year over the given investment period.

As returns from cash savings continue to fall, the availability of this predictable, bankable return creates a strong case for investment in EIS.

To ensure this return for clients, advisers should look for EIS products that offer capital protection with a structure that can return capital after three years.

CGT deferral is a pivotal feature of EIS, offering clients a unique window of opportunity to move gains – whether from property or stockmarket investments – into a lower tax bracket.

There are several aspects to this tax benefit. Not only can clients invested in an EIS defer tax on their current gains, they can also claw back capital gains tax they have already paid on gains made up to three years previously.

Furthermore, when this gain becomes payable again (after investments are sold), the gain is taxed at 18 per cent. So if a client’s historic gain was taxed at 40 per cent, there’s a 22 per cent saving (in addition to the 20 per cent income tax relief).

In an environment where every penny counts, the potential to save on past, present and future gains cannot be ignored. When these CGT benefits are combined with the income tax relief offered by EIS products, they can go a long way to helping clients reduce their tax bills.

Achieving exemption from inheritance tax is another key feature of EIS products. With many more estates liable for inheritance tax, this EIS benefit is of equal use to investors who are interested in long-term financial planning and those with a shorter investment horizon.

Inheritance tax can also be mitigated with specific IHT solutions. Over the last decade, these have developed to meet clients’ needs.

Clients are looking for products that offer them speed, simplicity and control. Yet many traditional IHT products have complex legal structures and can take up to seven years to fall outside the estate. Meanwhile, IHT-mitigating products such as trusts require clients to say goodbye to their money for good.

In contrast, the most innovative and popular products ensure inheritance tax exemption after just two years and clients always retain access to, and control of, their money. A secure IHT product offering a cash-beating, targeted return, underwritten by the company, that delivers on its objectives, should suit many clients.

Similarly, VCT and EIS products have also developed in line with clients’ requirements. In today’s volatile market, many clients will prefer to invest in tax-efficient products that offer protection and security for their capital alongside tax benefits. It is therefore worth looking into protected versions of VCTs and EIS.

Protection can be achieved in various ways, through holding a diversified portfolio of investments, only investing in protected businesses, and structuring investments so they are secure. This is done through careful product design first and then the work of a skilled fund manager.

Furthermore, it is the companies that offer to underwrite the return, or only collect a management fee if all the capital is returned, that can give clients the peace of mind they seek.

At a time when clients are looking to preserve as much cash as possible, VCT, EIS and IHT solutions can help them reduce their tax burden. These products can be used to mitigate past, present and future tax liabilities. In these ways, tax-efficient products can make a real difference to how much cash people have, now and in the long term.


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