This year, Tax Freedom Day occurred on Thursday, June 8. This particular date marks the point in the year when the average taxpayer in the UK has theoretically earned enough income to cover all their tax obligations. This includes taxes on income and the purchase of goods and services.
The tax burden currently stands at its highest level since 1949. Numerous allowances have been frozen until 2028, and there are significant reductions in dividend and capital gains tax allowances. Additionally, in 2023, there will be a notable increase of 232,000 individuals who will be subject to the additional 45 percent tax rate compared to the previous year. Fiscal drag, which involves the government freezing allowances instead of adjusting them to keep up with inflation, is causing more people to fall into higher tax brackets.
British taxpayers are required to work for the taxman for 159 days each year before they can start earning for themselves. To put it differently, Monday and Tuesday of every week are essentially spent covering tax obligations. Unfortunately, the situation does not appear likely to improve in the near future, as projections indicate that Tax Freedom Day may extend to June 24 by 2026. If this occurs, it would be the latest Tax Freedom Day has been since the early 1960s.
It comes as no surprise, then, that we are witnessing a growing trend of affluent investors seeking to invest in startup businesses as a means to reduce their tax liabilities. A recent survey conducted among Wealth Club clients revealed that tax incentives played a significant role in the continued success of Venture Capital Trusts (VCTs), which have experienced inflows of over £1 billion for two consecutive tax years. Investment in companies eligible for the Enterprise Investment Scheme (EIS) also reached a record-breaking £2.3 billion in the most recent available figures for 2021/22.
In reality, each individual’s Tax Freedom Day varies, but fortunately, there are still legal methods to bring forward your own personal tax freedom date. These methods range from simple actions like investing in pensions and ISAs to proactively addressing capital gains liabilities in the current year instead of waiting until the following year. Additionally, investing in early-stage businesses through government-supported investment schemes such as VCTs and EIS can also be beneficial.
1. Maximize your ISA allocations
If you have accumulated substantial investments, it is crucial to utilize your individual savings account (ISA) allowances to their fullest extent. You can contribute up to the annual allowance of £20,000 (applicable for 2023/24) into a Stocks & Shares ISA, a Cash ISA, or a combination of both. The interest or dividends you receive from an ISA are exempt from Income Tax, and any profits from investments are also free from Capital Gains Tax. The tax-free nature of ISA income becomes particularly advantageous during retirement, especially if your anticipated income surpasses the annual income tax threshold of £12,570 for basic rate taxpayers.
2. Leverage your pension
Saving for retirement through a pension scheme remains the preferred method for tax-efficient savings. The ability to obtain pension tax relief at your marginal income tax rate means that contributing £100 to a pension costs a higher rate taxpayer £60 or just £55 for an additional rate taxpayer. This substantial relief may not remain available indefinitely, so it is essential to take advantage of it while it lasts. However, it’s important to remember that upon retirement, you may be subject to income tax on the drawn income if it exceeds the income limits.
3. Utilize your Capital Gains Tax Allowance
At present, individuals benefit from a yearly capital gains tax allowance of £6,000, which means they can generate up to £6,000 in capital gains before becoming liable for capital gains tax. However, starting from April 2024, this allowance will decrease to £3,000. The importance is clear: use it wisely or risk losing it. Investors who are satisfied with their fund portfolio could consider selling a well-performing fund and purchasing something very similar. For instance, selling one US equity tracker and acquiring another.
4. Make use of your married couple’s allowance
If you are married or in a civil partnership and below 88 years of age, you may be eligible for the government’s reintroduced married couples’ allowance, which was reinstated last year. This allowance allows you to reduce your tax bill by transferring £1,260 of your personal allowance to your spouse or civil partner if they earn more. It is estimated that around 2.1 million couples qualify for this benefit, yet many fail to claim it. To qualify, you simply need to complete and submit the necessary documentation within your annual Self-Assessment tax return. If you neglect to do so, you will not receive the allowance.
5. Explore Venture Capital for Tax Benefits
- Venture Capital Trusts (VCTs) provide the opportunity to receive up to 30 percent income tax relief. This means that on a £10,000 investment, you could potentially get £3,000 back. Returns are distributed in the form of regular tax-free dividends, which is an attractive bonus. The annual allowance for VCT investments is a significant £200,000.
- Investments in the Enterprise Investment Scheme (EIS) also offer up to 30 percent income tax relief. While there are no tax-free dividends, one notable advantage is the ability to defer chargeable capital gains realized. As long as you remain invested in any EIS, you can postpone the capital gains tax (CGT) payment. It only becomes payable upon exiting the EIS, unless you reinvest the funds into another qualifying investment. The annual allowance for EIS investments is an impressive £1 million, or £2 million if you invest at least £1 million into “knowledge-intensive” companies.
- The Seed Enterprise Investment Scheme (SEIS) stands out as a tax-saving option. It provides up to 50 percent income tax relief and allows for a reduction in the capital gains tax bill. The generous annual allowance for SEIS investments is £200,000. Considering a £100,000 investment, it could potentially save you up to £50,000 in income tax and £14,000 in capital gains tax.
- Reclaiming already paid tax: An often overlooked benefit of EIS and SEIS investments (excluding VCTs) is the ability to “carry back” tax relief. This means you can choose to offset the tax relief against the previous tax year and reclaim tax that has already been paid. However, there is a condition. To carry back to the 2021/22 tax year, your investment must be made and the shares allotted by April 5th, 2023. If this deadline is not met, you can still offset the tax relief against the current tax year.
So far, tax reliefs associated with Venture Capital schemes have endured the recent wave of tax regulations. This is because they provide vital capital to dynamic young businesses, which are a driving force behind the UK economy. The tax relief serves as a crucial incentive for private investors and helps mitigate risks involved.
However, it’s important to note that Venture Capital investments are not solely driven by tax benefits. Investors are increasingly recognizing that growth and innovation are more likely to emerge from ambitious and entrepreneurial start-ups, rather than large corporations listed on the main stock market. While not all start-ups will succeed, there is now greater support available compared to a decade ago, including incubators, accelerators, and public and private funding, providing these ventures with a better chance at success.
6. Explore AIM ISAs to Minimize Inheritance Tax (IHT) Liability
Pensions can be passed down to the next generation with relatively favorable tax treatment. Similarly, EIS and SEIS investments are likely to be exempt from IHT after a two-year period. However, the most significant IHT risk often arises from an unexpected source: ISAs. Contrary to popular belief, ISAs are not exempt from IHT, which means that up to 40 percent of ISA savings could be subject to taxation.
One alternative worth considering is an AIM ISA, which offers a managed portfolio of AIM shares that can become IHT-exempt after two years. With an AIM ISA, you can still enjoy the benefits of tax-free income and growth throughout your lifetime, while being relieved of IHT concerns. In addition to investing your annual £20,000 ISA allowance into an AIM ISA, you can also transfer existing ISAs into an AIM ISA, thereby safeguarding that money from inheritance tax as well.
*Alex Davies, Chief Executive of Wealth Club*
