Tax efficient investments

• ISAs
• Enterprise investment scheme (EIS) and Venture Capital Trusts (VCT’s)
• Pension contributions

ISAs

• You can invest an amount in an ISA every year. The amount invested does not attract tax relief but the income and gains on the investment are tax free, so any taxpayer will benefit from the tax shelter on the income arising. Tax credits on dividend income cannot be recovered.
• The limits for ISA investments are changing. In 2009/10 the limits are £10,200 in total (with up to £5,100 in a cash ISA) if you are aged 50 or over in the tax year. The increased limit took effect on 6 October. For other savers the limit remains £7,200 (up to £3,600 in cash) until 2010/11, when the increased limits take effect for all savers.

Enterprise investment scheme (EIS) and Venture Capital Trusts (VCT’s)

• These two schemes allow ongoing tax relief on investments that are channelled into venture capital for smaller and growing businesses. By their very nature they are considerably more risky than ISA’s and other similar investment vehicles.
• The EIS scheme provides 20% tax relief on investments of up to £500,000 in a tax year, and investments can be carried back by up to one year provided the limit in the previous year was not reached.
• EIS shares are exempt from capital gains tax once they have been held for three years.
• Capital gains tax on the disposal of other assets can be deferred by reinvesting the proceeds in EIS shares. This relief is slightly different from the basic EIS relief, as there is no limit on the gain that can be reinvested in this way. However, the tax on the original gain will become payable when the EIS investment is sold. The reinvestment can take place up to three years after (or one year before) the original disposal.
• VCT investments are made through a fund, so the risk on individual investments is spread across the fund. The tax relief is 30% of the amount invested, with a limit of £200,000 in any tax year.
• VCT investments are not subject to capital gains tax if they are held for 5 years. Dividends are not subject to higher rate tax, but the tax credit is not repayable.

Pension contributions

• Pension contributions are paid net of basic rate tax, and the pension provider recovers the tax element. Up to £3,600 per year (gross) may be invested by any individual irrespective of whether they have earnings to match it or not.
• Pension contributions also save higher rate tax for those liable, and this relief is normally given through the self assessment return.
• In 2009/10 restrictions on relief have been introduced for those with income of more than £130,000. The income limit applies to the tax year and the two preceding years, so if your income is only £40,000 in 2009/10 but was £200,000 in 2007/08 you are still affected by the new rules.
• In general you will be able to pay in the same amount of pension contributions in 2009/10 and 2010/11 as you have previously, but if you have not made regular monthly or quarterly contributions you might incur a tax charge on contributions you pay annually.
• Contributions paid by your company are also taken into account for this new legislation, so you should take specific advice before making pension contributions through your company if your income is above the limit. If your income is less than £130,000 in all of the relevant years, the company can pay up to the annual allowance of £245,000 without you incurring a tax charge.
• There will be new rules again affecting pension contributions (including contributions by companies) in 2011, so the current regime will have a life of only two years. The 2011 regime has not yet been finalised but it is likely to include a tax charge on company contributions for those with income in excess of £130,000.