When the Chancellor of the Exchequer announced sweeping changes to the capital gains tax (CGT) regime in November, there was much wailing and gnashing of teeth, especially among small businesses.
The abolition of taper relief and introduction of a flat rate charge meant effective tax on disposal of a company rocketed from ten per cent to 18 per cent.
But what about investors who had recently disposed of an asset, say a buy-to-let home or a shares portfolio, charged at 40 per cent CGT? They were left feeling pretty sick when they saw the new 18 per cent rate.
However, potential relief from this is at hand in the form of the Enterprise Initiative Scheme (EIS). For anyone who has exhausted their entitlement to tax free investment within ISAs, National Savings and pensions, and who still has money to save, an Enterprise Investment Scheme could be worth a look.
It is the ability to roll over capital gains into an EIS and dispose of them in the future at a much better rate which makes them particularly attractive at the moment.
EISs were unveiled in November 1993, with the aim of assisting small, higher risk, unquoted trading companies to raise capital by offering a range of tax incentives to investors.
An EIS can involve investing in a single company or you can buy into an EIS fund which invests in a number of qualifying companies. Qualifying companies must have gross assets of £7 million or less, so we are talking quite small businesses. They can engage in most trades, but firms involved in some activities, for example share or property dealing, banking, nursing homes or hotels, are excluded.
The tax reliefs on EISs are extremely generous, in return for investing in what is definitely a high risk investment. The incentives include income tax relief, capital gains tax (CGT) exemptions, plus loss relief and deferral of CGT on other investments, providing you are a qualifying investor.
EIS holdings may also be exempt from inheritance tax as they qualify for business property relief after two years. This makes the tax incentives more wide-ranging than those available to Venture Capital Trust (VCT) investors who cannot claim CGT loss relief or deferral relief. However VCT investors currently get a higher rate of income tax relief, 30 per cent for 2007-08.
Income tax relief of 20 per cent is given on investments of between £500 and £400,000 per tax year in an EIS company or EIS fund, providing the investment is held for at least three years. However, income tax relief may be withdrawn if the investor becomes a "connected person" (owns more than 30 per cent of the firm) or the company ceases to be qualifying within three years of the share issue.
Investors will normally be entitled to exemption from CGT on disposal of EIS shares or funds, providing they have been held for more than three years (and they have received income tax relief on the purchase of the shares and the scheme remains qualifying).
If you have a CGT liability from the sale of previous investments and you invest the proceeds in an EIS company or fund, an unlimited CGT liability can be deferred. This has the advantage of deferring a gain charged at 40 per cent to a future gain charged at 18 per cent.
Many EIS providers will also allow the phased withdrawal of proceeds from an EIS to allow full use of the annual CGT allowances. Added to this, if the EIS is still held at death, not only is there no inheritance tax liability but the CGT liability dies with the owner.
Mr Jones is a 45-year-old professional, earning £90,000 a year. Earlier this year, he made a £100,000 profit selling a buy-to-let property, leaving him with a capital gains tax bill of £40,000. Faced with this situation, He decides to invest £100,000 into an EIS. By doing this, Mr Jones defers his capital gain of £40,000 and also receives income tax relief equal to £20,000.
The recent change to capital gains tax rates has a huge beneficial impact on Mr Smith. It allows him to defer his 40 per cent capital gains tax bill in the knowledge that when he comes to sell his shares (in three years time) the tax rate on this gain will have fallen from 40 per cent to 18 per cent providing him with what is in effect 22 per cent capital gains tax relief. Combined with his 20 per cent income tax relief, this means that Mr Smith will receive a total of 42 per cent tax relief.
Gains made in any of the preceding three tax years can be deferred in this way. Added to this, any gains made on the first £400,000 invested in the EIS are CGT free.
As the old saying goes: "There are two groups of people who complain about taxes - men and women". With access to the right information and advice, we can often end up with a little less to complain about.
* Trevor Law is a director with Montpelier Group (Europe) Ltd, the privately-owned independent financial advisers located at Barston near Solihull. TILaw@montpeliergroup.com