As UK Corporation Tax rates fall, an increasing number of wealthy investors are holding their investments through personal companies. This means that they pay only 20% Corporation tax which is very attractive in comparison to the marginal income tax rates which are set at45% and higher. In addition, some costs can be met from gross income that would otherwise have to be paid out of net income.
However, this is not without problems; by holding investments through personal companies, investors’ capital and accumulating returns are locked up in the company. To get it out as a dividend would put you pretty much back where you started, in terms of the effective overall tax rate.
One solution to this is to pay out cash as dividends, whilst at the same time building up an unquoted share portfolio using the Enterprise Investment Scheme (EIS). All of the income tax due on withdrawing cash from the company can be claimed using the 30% EIS tax relief. In order to take full advantage of this relief, the investor must put £1.50 into their unquoted portfolio for every £1 of gross investment being sheltered.
Investors with CGT liabilities will find this approach even more attractive, since CGT can be reclaimed of deferred according to the EIS rules. The CGT saving effectively means that only 80p needs to go into the unquoted share portfolio for every £1 of gross income sheltered.
That leaves the question: why would you want to build up an unquoted share portfolio? One of the reasons is value; private companies don’t have ready access to capital markets, so investors can get better terms when investing. Commentators often dismiss EIS companies as ‘high risk’, but many private companies are carefully managed by people whose livelihoods depend on them. Additionally, the Enterprise Investment Scheme offers loss relief, which means an investor can recover up to 45% of any loss against their income tax bill.
There will always be some losses in an equity portfolio, but spreading your investment across 10-20 different companies means that the specific risks rapidly become less important. One final thought: unquoted shares are outside your estate for inheritance tax purposes, so this simple strategy can deliver another 40% saving without any clever tax planning or loss of control.