- With tax obligations in the spotlight, wealthier investors can consider some lesser-known techniques
- We evaluate some overlooked options
The prospect of a tightening tax net may have prompted investors to act, but the more conventional paths to tax efficiency may have their limits. The annual tax-free £20,000 abatement on Isa contributions will so far only go to the wealthiest people, while frozen thresholds on capital gains tax (CGT) and allowance lifetime retirement only increase the pressure. Yet some lesser-known paths to tax efficiency exist. While each comes with its own complications, those who have exhausted the usual allowances might consider special measures.
take it private
As individuals, investors are subject to the usual taxes apart from a wrapper, including CGT if and when they exceed a threshold of £12,300 (in the current tax year) on gains made . However, there are ways to protect certain gains from the tax authorities apart from Isas and pensions.
Extremely wealthy individuals might consider setting up their own open-ended private investment company (Oeic), the structure commonly used for open-ended funds. The advantages here concern any portfolio rebalancing outside the tax envelope: individuals who have to rebalance a large portfolio in a taxed environment could accumulate a CGT bill by simply taking profits on their winners. An Oeic could solve this problem, because not all trades within the Oeic structure are subject to the CGT. An investor can only trigger a CGT event by selling the shares of the Oeic itself.
Jason Hollands, managing director of a wealth management firm Tilney, which recently acquired private provider Oeic Smith & Williamson, notes that an investor would need at least £5m to invest, given the costs of setting up such a structure. Oeics are operated by Authorized Corporate Directors (ACDs), who can appoint one or more investment managers, and investors can turn to a wealth manager to work out the arrangements.
“If you have a large portfolio, you need to keep that in mind,” Hollands says. “Just day-to-day or month-to-month movements in a portfolio [and rebalancing] could involve the crystallization of capital gains, so you must be careful not to exceed your exemption. »
The benefits of an Oeic held outside of a tax envelope are not limited to those with £5million or more to put to work. Investors who hold an Oeic, or even an investment fund, are not taxed on capital gains made within the fund structure. But capital gains realized on the sale of Oeic shares or investment fund shares are subject to CGT rules.
If you’re forced to hold funds outside of tax wrappers, your choice of investment can make a big difference. Higher octane choices such as equity funds may be more likely to see big gains over time and expose you to a CGT bill, requiring more careful management. That said, a bad year could result in losses that can, like a silver lining, be offset by your other earnings for CGT purposes.
The funds most likely to rebalance substantially are generally multi-asset funds, which can serve a purpose in a self-directed investor’s portfolio. the said estate preservation trusts and funds are an obvious example, as they add a defensive element to your portfolio. Typically, these vehicles should make modest gains compared to many equity funds, potentially exposing you to less CGT risk if you sell units or stocks.
Investors sometimes use multi-asset vehicles as the core of their portfolio, including funds of funds. These funds could realize greater gains depending on their exposure to equities. Investors can also rely on multi-asset funds to generate income. These can sometimes be heavily dependent on stocks, which can lead to big gains in good years.
Other solo options
Investors who have substantial but insufficient assets to justify a private Oeic might consider setting up an investment company. This would be cheaper than setting up an Oeic and subject the relevant part of the assets to companies rather than personal taxes. But it does involve additional work, including disclosing company information and setting up administrators, and the tax appeal can vary over time.
Hollands notes that people tend to set up personal investment companies “on the basis that corporate taxes are lower than personal taxes”, and the relative attractiveness could change if the chancellor overhauls the current regime. Corporate tax is expected to rise from its current rate of 19% to 25% in April 2023, but any future increases in personal tax rates, particularly CGT, could mean the corporate route remains attractive. As such, the potential tax implications of any assets held outside of packaging should be carefully assessed. A good tax advisor may be able to outline the pros and cons of this option.
Other options can be extremely complex. Matt Lewis, Certified Financial Planner at EQ Investors, suggests offshore investment bonds for people willing and able to invest for the longer term. These structures may house an investment portfolio and be issued by life insurance companies in jurisdictions that impose no tax on the income and capital gains of the underlying funds. Assets can be transferred within the structure without incurring tax, although the portfolio may be subject to withholding tax levied by foreign jurisdictions. As Lewis notes, the structure of offshore investment bonds allows you to “defer” taxation. A taxable gain will be assessed against income tax, which means that a higher or additional rate taxpayer could defer it until it has fallen into a lower tax bracket.
Events such as death, transfer of ownership or withdrawal in excess of a 5% annual tax-deferred allowance may trigger a tax event.
Although these are options for those who have exhausted their Isa and retirement allowances, the wraps remain the first port of call for the majority of investors. Other good practices also remain relevant: taking gains on investments outside of a tax envelope to avoid building up a large liability for CGT is a useful measure to take, however counter-intuitive it may seem. Other wallet techniques can alleviate your CGT issues. Since the average purchase cost of an investment is used to calculate your CGT bill, investing regularly can lower the potential bill for an asset that continues to make steady gains.
Another method that may be overlooked is the transfer of assets between spouses to take advantage of different deductibles and circumstances.
“The simplest financial planning a couple can do is juggle asset ownership through spousal transfers to optimize two sets of allowances,” Hollands notes. “Someone could be subject to lower tax rates in the form of capital gains or income tax. If you made a big profit on the stock, use your CGT allowance but, before the trade, transfer some of the shares or funds to your spouse to be sold against their CGT exemption There is usually no cost to do this, you just need to instruct your broker.
Some of these approaches may be a better way to reduce a tax bill than supporting riskier investments such as venture capital trusts (VCT). But this will always depend heavily on individual circumstances.