From 6 April 2010 those subject to UK tax and earning incomes over £150,000 will suffer 50% marginal rate of income tax. There are tax breaks available to mitigate the tax bill but these can be risky.
Saving on Tax by Converting Income to Capital Gains
Converting income into capital gains is one of the popular tax saving strategies. Because capital gains tax is levied at a flat rate of 18%, converting income assets to those that are subject to CGT seems an attractive option. Two examples are holding a currency account (where a tax-free gain may be possible on conversion) or investment property.
But currencies are volatile so holding a currency account purely for the purposes of a tax saving is not a good idea. As for investment property, especially in times of declining property prices, any potential tax savings must be weighed against the risk of losing the original capital.
Offshore Bonds as Tax Saving Investments
Income tax is only paid on these when the bond is cashed in. So, shifting from a higher rate to lower rate (e.g. on retirement) by the time the bond is cashed in will be beneficial in tax saving terms. However, these investment bonds attract high advisory fees and the choice of underlying investment can be limited (so many may perform badly). Besides, especially if retirement is some way off, it is not possible to predict the exact rate of tax when the bond is cashed in. And the tax rules may change in future.
Tax Saving Schemes
Both venture capital trusts (VCTs) and enterprise investment schemes (EISs) offer big income tax breaks.
With VCTs, investors get 30% income tax relief on up to £200,000 a year (provided the investment is held for five years or more), the dividends are tax-free and any profits are not subject to capital gains tax. EISs guarantee income tax relief of 20% but dividends (if any) are taxable. However, CGT arising on an EIS disposal can be rolled into another EIS and thus capital gains tax payable could be deferred indefinitely. Finally, an EIS is not included in an estate for inheritance tax purposes.
However, many of these schemes fail because they invest in risky business start-ups. Also, they can attract high initial, annual and performance fees.
Other Tax Saving Options
Zero-dividend shares (typically issued by split-capital investment trusts) pay no income but are redeemed at face value at a set future date. Any profit is subject to the flat 18% CGT rate (after annual CGT allowance), and they currently return approx 6% per annum. But locking cash for a number of years isn’t risk free and the end return may be below what some current five-year fix-rate ISAs offer.
The above examples of tax breaks demonstrate that some tax saving strategies come with big risks so they may not be appropriate for some investors, especially those who are very risk-averse.
References:
Bennett, Tim. “Don’t Dodge Tax Only to Walk Into Losses.” MoneyWeek, 5 March 2010.
