Tax-Efficient Investing in the UK

Investment strategies naturally vary, from institutional and retail investors to those with short time horizons and a high-risk acceptance profile or investors looking for fairly stable returns with reduced downside potential.

However, across the board, tax considerations are important, both for businesses and private investors, since their tax position could make a significant impact on their net returns and overall wealth.

In an inflationary economy, tax becomes even more influential, where small efficiencies can be meaningful in capital preservation and securing optimal returns, regardless of the specific investment product, fund or vehicle.

In this blog EMV Capital summarises some of the key tax-efficient investment opportunities and tax wrappers within the UK and explains how reliefs and exemptions vary to demonstrate the advantages available.

Please note that the information below is for general informational purposes only. For further clarification, please seek professional tax advice before making financial decisions.

4 Tax Efficient Investments in the UK

Individual Savings Accounts

ISAs are probably the most well-known tax-efficient savings option and act as a tax wrapper providing generous returns, although with capped contribution thresholds per year and some limitations on drawdowns related to specific products such as Lifetime ISAs.

This hybrid investment and savings account is government-backed, and since being launched in 1999, there are now varied products, including the following:

Cash ISAs
Stocks and Shares ISAs
Lifetime ISAs
Innovative Finance ISAs

While we’re focused here on tax exposure and efficiencies, it is important to note that varied ISAs have different risk profiles, features and asset structures, although in all cases, the capital invested grows outside of the scope of income tax or capital gains.

An ISA is less dynamic and has capped growth compared to other higher-risk investments, but from a tax perspective is highly advantageous, and although many ISA holders tend to prefer Cash ISAs, there is a growing appetite for alternative Innovative Finance ISAs, which work more like a conventional investment product.

These investment ISAs offer higher interest rates but are also associated with higher risk, so every investor should ensure the tax-efficient products they select are aligned with their risk tolerance.

Tax Efficiencies on Pension Investment

We often think of pensions as a long-term savings product, but the reality is that a well-invested pension with diversified funds and an assortment of asset classes and sectors is as much an investment as any other – with excellent benefits in terms of taxation.

Pension schemes and funds can range from defined benefit and contribution products to self-invested private funds and even overseas pension products, but the tax treatment is generally more generous than for any other investment, even if in the same asset held outside of a pension structure.

Allowances and tax thresholds also changed from April 2023, meaning that those investing for later life can save as much as they wish without incurring heavy tax penalties for funds exceeding the previous Lifetime Allowance of £1.073 million.

Tax relief is applied to contributions made at your prevailing tax bracket, and the recent reforms have lifted the annual allowance from £40,000 to £60,000. However, investors should be aware of adjusted income limits, which taper the annual allowance for individuals earning over £200,000 per year for the 2023/24 tax period.

Like ISAs, pensions grow free from tax obligations, and you can choose funds with greater flexibility and investment freedoms, such as Self-Invested Personal Pensions (SIPPs), which allow you to invest in a broad array of allowable assets such as bonds, venture capital or other areas.

Venture Capital Investment Options

There are three primary ways that investors can gain access to tax efficiencies within the venture capital landscape; through the Enterprise Investment Scheme, Seed Enterprise Investment Scheme, or Venture Capital Trusts.

Each of these investment categories is intended to incentivise investment into small, early-stage businesses with good growth potential, where the company meets a range of criteria based on their trade, sector, balance sheet value and workforce.

Enterprise Investment Scheme

The Enterprise Investment Scheme (EIS) was the first such initiative and was launched back in 1994 to encourage greater investment into businesses needing capital to scale and grow, focusing on unlisted companies and providing tax reliefs for investors.

While the scheme has evolved somewhat in the interim, it remains a viable option and has raised more than £25 billion in private investment. The inherent risks associated with early-stage business investment should never be disregarded, but the tax efficiencies on offer offset that exposure to some extent.

Investor tax reliefs include:

Up to 30% income tax relief on the capital value invested.
Exemption from capital gains tax on the sale of EIS shares.
Inheritance tax exemption.
Loss relief to offset capital losses if the company fails or share value falls.

You can read more about EIS tax relief here.

Income tax relief is particularly attractive to high earners and investors with significant tax obligations, with the 30% relief immediately mitigating the potential loss of a third of the capital invested.

Other advantages, such as deferral relief, can also be used to defer other capital gains tax obligations indefinitely by reinvesting the gain – rather than the total value – into an EIS-compliant fund or company. For further information, read about the benefits of investing in an EIS fund here.

Seed Enterprise Investment Scheme

The SEIS is a newer incarnation based on similar principles to EIS, but it has a more targeted approach and provides tax reliefs and exemptions to incentivise investment into new start-ups at an earlier stage of development to those eligible for EIS status.

Eligibility criteria are more rigorous, and qualifying companies must, for example, have been trading for no more than two years and have no more than 25 employees, but the tax treatments are equally useful at offsetting other liabilities or reducing the investment risk.

You can read more about the differences between SEIS and EIS here.

Tax Reliefs Available Through SEIS Investment

Because start-ups ventures are necessarily more exposed to failure than those inviting investment through EIS, the reliefs are also more generous, including:

Enhanced income tax relief of up to 50% of the capital investment value.
Capital gains reinvestment relief, providing up to 50% capital gains tax reductions on funds reinvested into SEIS shares.
Other advantages such as inheritance tax exemption and loss relief.

As always, a thorough analysis of the business plan, use cases, and trading history is important since newly formed organisations may have more potential to fail, but investors can benefit from rapid and significant capital growth where their selected investment fund or company expands substantially over a short period.

Investing in Venture Capital Trusts

The final investment option we’ll explore today is Venture Capital Trusts, or VCTs, which have some similarities to the EIS and SEIS schemes in terms of tax reliefs, but the investment structure is different.

VCTs are designed for investments into a fund linked to several companies, normally managed and monitored by an experienced fund manager.

This scheme launched in 1995, and acts as a listed business which collates capital investments from all contributing parties to invest across a large, actively managed portfolio comprising varied eligible businesses and organisations.

Since VCT funds are based on a managed structure, the VCT portfolio is more diverse and offers access to a number of early-stage enterprises, which are selected by the fund manager to meet the objectives of their investment clients.

Eligible VCT investment companies are also listed on the Alternative Investment Market (AIM), a branch of the London Stock Exchange (LSE) that deals with higher-risk and smaller companies. Returns depend on the performance of the overall portfolio but can generate capital growth through the fund share value.

Tax Reliefs Available Through VCT Investment

VCT investment funds include businesses at a more mature operating stage than earlier venture capital initiatives, and so the tax reliefs are subsequently reduced in light of the mitigated risk. However, investors benefit from tax efficiencies such as:

Up to 30% income tax relief upfront.
Tax-free dividend payments, with exclusion from dividend allowances.
Exemption from capital gains tax on share value capital growth.

The primary contrast between VCT investment and SEIS or EIS alternatives is the type of eligible company and the managed approach to investing, but all provide either opportunities to make direct investments or opt for a managed investment through a fund.

While all three venture capital schemes provide tax efficiencies, they also have requirements and limitations, such as the amount of time the investor needs to retain their investment to benefit from all available tax reliefs and caps on annual investment values.

For example, SEIS and EIS funds need to be held for three years, and VCT funds for five, with annual allowances ranging from £200,000 to £2 million.

Choosing the Right Approach to Tax-Efficient Investing in the UK

These examples are some of the more established and accessible tax-efficient investment products, but they are by no means the only potential solutions or the only investment structures that can provide benefits in terms of the tax obligations arising.

Investment begins with establishing a clear strategy to outline the primary objective, whether to achieve inflation-beating returns, create a financial cushion for later life planning, or preserve wealth to pass onto younger generations as part of estate planning.

Once investors have clarified their thresholds, risk parameters and other core factors, they can then make informed decisions about which tax-efficient investments are best aligned with their targets and expectations.