Brian runs his own IT company and has more than £50,000 of profits accrued in the business. He would like a tax efficient way to take the profits out so he can use it as a deposit for a holiday home.
The problem is that Brian is already receiving an annual income that places him in the higher rate banding for income tax. A further £100,000 dividend payment from his company would be taxed at an effective rate of 25%*. This means he would pay £12,500 in tax, shrinking his £50,000 to £37,500!
A POTENTIAL TAX-EFFICIENT SOLUTION
After speaking to Blue Sky and carefully weighing up the risks, Brian invests his £50,000 in an EIS. He stands to receive upfront income tax relief of £15,000, which would more than offset the £12,500 tax due on the dividend. Brian acknowledges he must hold his EIS shares for a minimum of three years in order to retain the income tax relief.
Brian’s EIS shares will also give him the following tax advantages:
- Inheritance tax relief: Brian’s EIS shares will be free from inheritance tax after two years and provided they are held at the time of death
- No capital gains tax: After three years, there will be no capital gains tax to pay on the shares when they are sold
- Tax-free growth: There is no capital gains tax to pay if the EIS investment increases in value
- Loss relief: At the current rates of income tax, up to 45% loss relief is available on any holdings realised at a loss (net of income tax relief claimed). This is one of the most compelling features of an EIS, as it can help reduce the impact of losses from individual investments and may improve the risk/return profile of the overall EIS portfolio.
* These rates take into account the 10% dividend tax credit. While it is not possible to claim back the dividend tax credit via VCT or EIS investment, it is possible to use relief to offset the additional personal tax created from the payment of dividend income.
† Tax relief on EIS is based on the investment amount after charges (i.e. net). Tax relief on VCT is based on the investment amount before charges (i.e. gross).
This client tax scenario is designed to assist you in developing your own strategy where appropriate. Among other things, you will need to consider eligibility and timings of tax reclaims and tax liabilities depicted, and also the impact of charges (i.e. initial fee and ongoing fees, including administration fee and an annual management charge), as relevant to the product(s). This case study does not constitute financial advice or guidance. If you would like to discuss your personal situation, please contact us.