Pensions and other tax efficient investment products

Introduction
In the previous chapter we looked at the basic income tax computation. We
now look at some of the tax reliefs given to encourage individuals to invest in
certain types of savings.
The most important type of saving is through pensions. Tax relief is given on
contributions to pension schemes, and the schemes themselves can grow tax
free. There are limits on the amounts that can be invested, and breach of these
limits will incur tax charges. Failure to comply with the rules will also result in
tax charges.
Investment in smaller companies is encouraged through the enterprise
investment scheme, the seed enterprise investment scheme and venture capital
trusts. We saw how relief is given as a tax reducer in the previous chapter, and
here we will examine the conditions which must be satisfied before relief is
available.
In the next chapter, we will look at income from UK property and other
investments.

Study guide
Intellectual level
1 Income and income tax liabilities in situations involving further overseas aspects and in relation to trusts, and the application of exemptions and reliefs
(a) The contents of the Paper F6 study guide for income tax and national insurance, under heading: 2
• B7 The use of exemptions and reliefs in deferring and minimising income tax liabilities
(g) The use of exemptions and reliefs in deferring and minimising income tax liabilities:
(i) Understand and apply the rules relating to investments in the seed enterprise investment scheme and the enterprise investment scheme 3
(ii) Understand and apply the rules relating to investments in venture capital trusts 3
Exam guide
You may well come across pension contributions or investments under the EIS, under the SEIS, or in VCTs as part of a question. These investments all give tax relief for the amount invested, although the reliefs vary in amount. They are commonly used to mitigate tax liabilities, but you should note that they should be used for in-year tax planning, although there is carry back for EIS and SEIS reliefs.

This chapter builds upon the basic knowledge of tax relief for pension contributions necessary in Paper F6. The examination team has identified essential underpinning knowledge from the F6 syllabus which is particularly important that you revise as part of your P6 studies. In this chapter, the relevant topic is:
Intellectual level
B7 The use of exemptions and reliefs in deferring and minimising income tax liabilities
(a) Explain and compute the relief given for contributions to personal pension schemes, and to occupational pension schemes 2
The main change for 2015/16 from the material you studied at F6 is the introduction of pension flexibility as regards how individuals can access their pension fund on reaching the minimum pension age of 55.
EIS, SEIS and VCTs are new topics.

One of the competencies you require to fulfil Performance Objective 17 Tax planning and advice of the PER is to review the situation of an individual or entity advising on any potential tax risks and/or additional tax minimisation measures. You can apply the knowledge you obtain from this chapter of the text to help to demonstrate this competence.

1 Types of pension scheme and membership
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An employee may be entitled to join their employer’s occupational pension scheme. Both employees and the self employed can take out a ‘personal pension’ with a financial institution such as a bank or building society.
1.1 Types of pension provision
An individual is encouraged by the Government to make financial provision to cover their needs when they reach a certain age. There are state pension arrangements which provide some financial support, but the Government would like an individual not to rely on state provision but to make their own pension provision.
Automatic enrolment is being introduced so that employers must automatically enrol most employees into a workplace pension scheme (although employees can then opt out of the scheme). Under automatic enrolment, there are minimum contributions to the workplace pension scheme required by law (up to 30 September 2017 usually equal to 2% of earnings of which a minimum amount equal to 1% of earnings must be contributed by the employer).
Alternatively, individuals (employees, self-employed and those who are not working) may make their own pension provision through a personal pension provider such as an insurance company.
Tax relief is given for both employer pension provision and personal pension provision. This includes relief for contributions to a pension and an exemption from tax on income and gains arising in a pension fund.
1.2 Pension arrangements
An individual may make pension provision in a number of ways.
Key terms
Occupational pension schemes are run by employers for their employees. Personal pension schemes are run by financial institutions: anyone may contribute to a personal pension.
Personal pension schemes and the majority of occupational pension schemes are money purchase schemes. These are also known as defined contributions schemes. The level of pension that the member can draw from such schemes will depend on the investment performance of the money invested.
Some occupational schemes are final salary schemes, where the pension depends on the period for which the individual has been a member of the scheme and their salary at the time of retirement. These are also known as defined benefits schemes, and are becoming less common due to the high level of contributions required.
An individual may make a number of different pension arrangements depending on their circumstances. For example, they may be a member of an occupational pension scheme and also make pension arrangements independently with a financial provider. If the individual has more than one pension arrangement, the rules we will be looking at in detail later apply to all the pension arrangements they make. For example, there is a limit on the amount of contributions that the individual can make in a tax year. This limit applies to all the pension arrangements that they make, not each of them.
2 Contributing to a pension scheme
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An individual can make tax relievable contributions to their pension arrangements up to the higher of their earnings and £3,600. Contributions to personal pensions are paid net of basic rate tax. Employers normally operate ‘net pay’ arrangements in respect of contributions to occupational schemes.
2.1 Contributions by a scheme member attracting tax relief 6/12, 6/13
An individual who is under the age of 75 is entitled to tax relief on their contributions to a registered pension scheme in a tax year.
The maximum contributions made by an individual in a tax year attracting tax relief is the higher of:
(a) the individual’s UK relevant earnings chargeable to income tax in the year; and (b) the basic amount (set at £3,600 for 2015/16).
Relevant UK earnings include employment income, trading income, and income from furnished holiday lettings (see later in this Text). If the individual does not have any UK earnings in a tax year, the maximum contribution they can obtain tax relief on is £3,600.
Where an individual contributes to more than one pension scheme, the aggregate of their contributions will be used to give the total amount of tax relief.
There is an interaction between this provision and the annual allowance, which will be discussed later.
2.2 Methods of giving tax relief
2.2.1 Relief given at source
This method will be used where an individual makes a contribution to a pension scheme run by a personal pension provider such as an insurance company.
Relief is given at source by the contributions being deemed to be made net of basic rate tax. This applies whether the individual is an employee, self-employed or not employed at all and whether or not they have taxable income. HMRC then pay the basic rate tax to the pension provider.
Further tax relief is given if the individual is a higher rate or additional rate taxpayer. The relief is given by increasing the basic rate limit and the higher rate limit for the year by the gross amount of contributions for which the taxpayer is entitled to relief.

Joe has earnings of £60,000 in 2015/16. He pays a personal pension contribution of £7,200 (net). He has no other taxable income.
Show Joe’s tax liability for 2015/16.

Non savings
Income
£
Earnings/Net income 60,000
Less personal allowance (10,600) Taxable income 49,400 Tax
£
£40,785 (W)  20% 8,157 £8,615  40% 3,446
49,400 11,603

Working
Basic rate limit £31,785 + (£7,200  100/80) = 40,785

In this question, higher rate relief of 20% has been obtained as non savings income, ordinarily taxed at 40%, has instead been taxed at 20%. Added to the basic rate relief of 20% given at source due to the pension payment being made net, this gives 40% relief.
The effective rate of relief can be higher where dividend income is also received in the year, as the higher rate relief on dividends shifted from higher rate to the basic rate is 22½% (32½% –10%).
2.2.2 Example: rate of tax relief
Adam has earnings of £46,270 in 2015/16. He also receives net dividends of £11,250. He is thinking of making a contribution of £7,200 (equivalent of £9,000 gross) to his personal pension. Adam’s effective rate of tax saved by making the pension contribution can be found as follows:
Non savings Dividend
income income
£ £
Earnings 46,270
Dividends  100/90
Less personal allowance (10,600)
Taxable income
Tax (before contribution) 35,670 12,500
£
£31,785  20% 6,357
£3,885  40% 1,554
£35,670
£12,500  32½% 4,062
48,170
Tax (after contribution) 11,973
£
£35,670  20% 7,134
£5,115  10% 511
£40,785 (W)
£7,385  32½% 2,400
48,170 10,045
Net income 46,270
Working
Basic rate limit £31,785 + (£7,200  100/80) = £40,785
The tax saved by increasing the basic rate limit is £1,928 (£11,973 – £10,045). If we add to this the basic rate tax saved by making the contribution net (ie £9,000 – £7,200 = £1,800) the total tax saved is £3,728.
The effective rate of tax relief on the pension contribution is  100, which is 41.42%.

2.2.3 Adjusted net income
Adjusted net income is net income less the gross amounts of personal pension contributions (and gift aid donations – these are not in your syllabus). The restriction on the personal allowance is calculated in relation to adjusted net income.

Maria earns a salary of £116,000 in 2015/16. In January 2016, she made a net personal pension contribution of £5,000.
Compute Maria’s income tax liability for 2015/16.

Non savings
income
£
Salary/Net income 116,000
Less personal allowance (W) (5,725)
Taxable income 110,275
Income tax £ £
Basic rate £31,785 + (£5,000  100/80) 38,035  20% 7,607
Higher rate 72,240  40% 28,896
110,275 36,503

Working £
Net income 116,000
Less personal pension £5,000  100/80 (6,250)
Adjusted net income 109,750
Less income limit (100,000)
Excess 9,750

Personal allowance 10,600
Less half excess £9,750  ½ (4,875)
5,725

Where an individual has an adjusted net income between £100,000 and £121,200, the rate of tax on the income between these two amounts will usually be 60%. This is calculated as 40% (the higher rate on income) plus 40% of half (ie 20%) of the excess adjusted net income over £100,000 used to restrict the personal allowance. The individual should consider making personal pension contributions to reduce adjusted net income to below £100,000.
2.2.4 Net pay arrangements
An occupational scheme will normally operate net pay arrangements.
In this case, the employer will deduct gross pension contributions from the individual’s earnings before operating PAYE. The individual therefore obtains tax relief at their marginal rate of tax without having to make any claim.

Maxine has taxable earnings of £60,000 in 2015/16. Her employer deducts a pension contribution of £9,000 from these earnings before operating PAYE. She has no other taxable income.
Show Maxine’s tax liability for 2015/16.

£
Earnings 60,000
Less pension contribution (9,000)
Net income 51,000
Less personal allowance (10,600) Taxable income 40,400
Tax
£
£31,785  20% 6,357
£8,615  40% 3,446
40,400 9,803

This is the same result as Joe in the question earlier in this Chapter. Joe had received basic rate tax relief of £(9,000 – 7,200) = £1,800 at source, so his overall tax position was £(11,603 – 1,800) = £9,803.

2.3 Contributions not attracting tax relief
An individual can also make contributions to their pension arrangements which do not attract tax relief, for example out of capital. The member must notify the scheme administrator if they make contributions in excess of the higher of their UK relevant earnings and the basic amount.
Such contributions do not count towards the annual allowance limit (discussed below) but will affect the value of the pension fund for the lifetime allowance.
2.4 Employer pension contributions 6/10
Employers may make contributions to pension schemes. In certain circumstances employers contributions are spread over a number of years.
FAST FORWARD
2.4.1 Taxation consequences of employer pension contributions
Where the active scheme member is an employee, their employer will often make contributions to their pension scheme and under automatic enrolment are required by law to make at least minimum contributions to a workplace pension scheme. Employer pension contributions to any type of pension scheme are exempt benefits for the employee.
There is no limit on the amount of employer pension contributions that may be made but such contributions always count towards the annual allowance and will also affect the value of the pension fund for the lifetime allowance (see further below).
All contributions made by an employer are made gross and the employer will usually obtain tax relief for the contribution by deducting it as an expense in calculating trading profits for the period of account in which the payment is made.
2.4.2 Disallowance of employer pension contributions
HMRC may seek to disallow an employer pension contribution which it considers is not a revenue expense or is not made wholly and exclusively for the purposes of the trade.
2.4.3 Large employer pension contributions
There are ‘spreading provisions’ for large employer pension contributions, so that part of the contribution is treated as paid in a later period of account.
2.5 Annual allowance 6/13, 12/15
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The annual allowance is the limit on the amount that can be paid into a pension scheme each year. If this limit is exceeded there is an income tax charge on the excess contributions. Unused annual allowance can be carried forward for up to three years.
2.5.1 Introduction
The annual allowance effectively restricts the amount of tax relievable contributions that can be paid into an individual’s pension scheme each year. The amount of the annual allowance for 2014/15 and 2015/16 is £40,000. The amount of the annual allowance for 2012/13 and 2013/14 was £50,000.
Exam focus These amounts will be shown in the tax rates and allowances in the exam. There are some complex point transitional rules which mean that for 2015/16 the annual allowance could be more than £40,000 for some individuals depending on when contributions were made in the year. These transitional rules are not examinable in P6(UK) and you should assume that in any exam question involving pensions the timing of the contributions means that only an annual allowance of £40,000 is available for 2015/16. This assumption will also apply in relation to carry forward of unused annual allowance to future years.
2.5.2 Carry forward of unused annual allowance
Where an individual is a member of a registered pension scheme but does not make contributions of at least the annual allowance in a tax year, the individual can carry forward the unused amount of the annual allowance for up to three years.
The annual allowance in the current tax year is treated as being used first, then any unused annual allowance from earlier years, using the earliest tax year first.

Ted is a sole trader. His gross contributions to his personal pension scheme have been as follows:
2012/13 £26,000
2013/14 £46,000
2014/15 £25,000
In 2015/16 Ted has a good trading year and wishes to make a large pension contribution in January 2016.
(a) What is the maximum gross pension contribution Ted can make in January 2016 without incurring an annual allowance charge, taking into account any brought forward annual allowance?
(b) If Ted makes a gross personal pension contribution of £43,000 in January 2016, what are the unused annual allowances he can carry forward to 2016/17?

(a)
£
Annual allowance 2015/16 40,000
Annual allowance unused in 2012/13 £(50,000 – 26,000) 24,000
Annual allowance unused in 2013/14 £(50,000 – 46,000) 4,000 Annual allowance unused in 2014/15 £(40,000 – 25,000) 15,000
Maximum gross pension contribution in 2015/16 83,000

(b)
£
Annual allowance 2015/16 used in 2015/16 40,000
Annual allowance unused in 2012/13 used in 2015/16 3,000 Contribution in 2015/16 43,000
The remaining £(24,000 – 3,000) = £21,000 of the 2012/13 annual allowance cannot be carried forward to 2016/17 since this is more than three years after 2012/13. The unused annual allowances are therefore £4,000 from 2013/14 and £15,000 from 2014/15 and these are carried forward to 2016/17.

Exam focus The use of annual allowances was tested in June 2013 Qu 3(a)(i) Shuttelle. The examiner commented that point ‘Many candidates were aware that there was a three-year rule in respect of the annual allowance, although
many were not absolutely clear as to how the rule worked.’
2.5.3 Contributions in excess of annual allowance
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An annual allowance charge arises if tax-relievable contributions exceed the available annual allowance.
If tax-relievable pension contributions exceed the annual allowance, there is a charge to income tax based on the individual’s taxable income. This will occur if the taxpayer has relevant earnings in excess of the available annual allowance and makes a contribution in excess of the available annual allowance (including any brought forward annual allowance).
The taxpayer is primarily liable for the tax on the excess contribution but in certain circumstances can give notice to the pension scheme for the charge to be payable from the taxpayer’s pension benefits fund.
The annual allowance charge is calculated by taxing the excess contribution as an extra amount of income received by the taxpayer. The calculation therefore claws back the tax relief given on the pension contribution.

Jaida had employment income of £240,000 in 2015/16. She made a gross personal pension contribution of £70,000 in 2015/16. She does not have any unused annual allowance brought forward. What is Jaida’s income tax liability for 2015/16?

Non-savings

£
Taxable income (no personal allowance available) 240,000
Tax
£101,785 (W1)  20% 20,357
£118,215  40% 47,286
£220,000 (W2)
£20,000  45% 9,000
£240,000 (W2)
£30,000 (W3)  45% 13,500
Income tax liability 90,143

Workings
1 Basic rate limit £31,785 + £70,000 (gross contribution) = £101,785
income
2 Higher rate limit £150,000 + £70,000 (gross contribution) = £220,000
3 Excess pension contribution £(70,000 – 40,000) = £30,000

3 Receiving benefits from pension arrangements
One of the competencies you require to fulfil Performance Objective 17 Tax planning and advice of the PER is to assess the tax implications of proposed activities or plans of an individual or entity with reference to relevant and up to date legislation. You can apply the knowledge you obtain from this section of the text to help to demonstrate this competence.
3.1 Pension benefits New in FAs15
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An individual can start to receive pension benefits from the age of 55. Under flexible access drawdown, a tax-free lump sum of 25% of the pension fund can be taken and the remainder reinvested to give taxable pension income as required.
After reaching the minimum pension age of 55, an individual can start to receive pension benefits with complete flexibility to access their personal pensions.
There are a number of common ways in which an individual can receive benefits from personal pension schemes. One is flexible access drawdown where the individual usually takes a tax-free lump sum of 25% of the pension fund. The rest of the pension fund is then reinvested to provide taxable pension income as required by the individual. Previously individuals usually had to buy an annuity with the balance (which is still an option).
Exam focus There is an anti-avoidance annual allowance limit which applies when an individual starts to receive point pension benefits flexibly but is also entitled to make further contributions to the pension fund. This annual allowance limit is not examinable in P6(UK).
3.2 The lifetime allowance 12/15
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The maximum value that can be built up in a pension fund is known as the lifetime allowance.
An individual is not allowed to build up an indefinitely large pension fund. There is a maximum value for a pension fund (for money purchase arrangements) or for the value of benefits (for defined benefits
arrangements). This is called the lifetime allowance. This allowance applies to the total funds built up in an individual’s pension funds. The amount of the lifetime allowance in 2015/16 is £1,250,000.
The individual does not have to keep a running total of the value of their pension scheme. Instead, the lifetime allowance limit is tested only when a benefit crystallisation event occurs. When a member takes a benefit from a pension scheme, there is usually a benefit crystallisation event so that the value of the pension fund has to be tested against the lifetime allowance for the year in which the event occurs.
In many cases, the lifetime limit will not have been exceeded and there will be no income tax charge. In some cases, the pension fund will exceed the lifetime allowance and this will give rise to an income tax charge on the excess value of the fund. The rate of the charge depends on the type of benefit that will be taken from the excess funds.
Where funds are used to provide a lump sum, there will be a charge to tax at 55% on the value of the lump sum. Where the excess funds are used to provide a pension income, the rate is 25%.
3.3 Example: lifetime allowance exceeded
Amy attained the age of 55 on 1 July 2015 and decided to start taking her pension benefits on that date. She has a money purchase fund which was valued at £2,050,000 on 1 July 2015. Amy took the maximum tax-free lump sum of £1,250,000  25% = £312,500. The balance of the lifetime allowance is £(1,250,000 – 312,500) = £937,500 and this will be used to provide pension income by flexible access drawdown.
Amy also took the excess of the fund over the lifetime allowance as a lump sum ie £(2,050,000 – 1,250,000) = £800,000.
The tax charge is therefore £800,000  55% = £440,000.
4 The enterprise investment scheme (EIS) 12/13
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The enterprise investment scheme, seed enterprise investment scheme and venture capital trusts are designed to help unquoted trading companies raise finance.
Key term The enterprise investment scheme (EIS) is a scheme designed to promote enterprise and investment by helping high-risk, unlisted trading companies raise finance by the issue of shares to individual investors who are unconnected with that company.
4.1 Conditions for relief
Individuals who subscribe for EIS shares are entitled to both income tax and capital gains tax reliefs where certain conditions are satisfied.
4.1.1 The investor
The investor must subscribe for shares wholly in cash in the company and must not be connected with it. Connection can broadly occur through employment or owning more than 30% (including holdings of associates ie spouse/civil partner or child, but not a brother or sister) of the issued ordinary share capital, issued share capital or voting power of the company or a subsidiary. The investor must also qualify for the two years prior to and three years after the share issue date or if later, three years from the date trading commences.
From 18 November 2015, there is a further requirement that the investor claiming relief cannot hold any other shares in the company at the time the investment is made. There is an exception to this requirement where existing holdings of shares are risk finance investments (eg EIS shares, SEIS shares).
4.1.2 The company
The company must have a permanent establishment in the UK throughout the qualifying period for income tax relief. A permanent establishment is either a fixed place of business through which the business of the company is wholly or partly carried on or an agent acting on behalf of the company who has and habitually exercises authority to enter into contracts on behalf of the company.
The company must be unquoted (eg not listed on a recognised stock exchange) and the funds raised must be used by that company or by a 90% subsidiary in carrying out a qualifying business activity. Qualifying business activities include carrying on qualifying trades, which broadly include all trades except for certain prohibited trades, including dealing in land, financial activities, legal/accountancy services and property backed activities. Research and development prior to starting a trade is also a qualifying business activity. From 18 November 2015, using money raised by an EIS share issue for a takeover of another company or for the acquisition of an existing trade are not qualifying business activities.
The money raised by the EIS share issue must be used for a qualifying business purpose within two years of the issue of the shares (or within two years of the commencement of the trade).
From 18 November 2015, the company making an EIS share issue must either be no more than seven years old or, if it is more than seven years old, must have raised qualifying funds in its first seven years. Shares may be issued after this time if the amount of the investment is at least 50% of the annual turnover of the company, averaged over the previous five years.
The company must have fewer than 250 full-time employees (or their equivalents) on the date of the share issue.
The gross assets of the company must not exceed £15m prior to nor £16m after the investment. The company must not have raised more than £5m in venture capital schemes (EIS, VCT and SEIS) in the 12 months ending on the date of the investment.
The company must meet the financial health requirement when the shares are issued. This requirement is that the company is not ‘in difficulty’ as defined in the Community Guidelines on State Aid for Rescuing and Restructuring Firms in Difficulty (2004/C 244/02).
From 18 November 2015, there is a lifetime cap of £12 million on the total amount of investment a company may receive under the EIS, SEIS and VCT rules.
There are different rules for knowledge-intensive companies. These rules are excluded from the P6 (UK) syllabus.
Exam focus point
4.1.3 The shares
Eligible shares are usually any new ordinary shares issued for bona fide commercial reasons which, throughout the period of three years beginning with the date on which they are issued, carry no preferential rights to assets on liquidation of the company. The shares may carry certain preferential rights to dividends but these are limited, for example, the rights to dividends cannot be cumulative.
The shares must be fully paid up at the time of issue and they cannot be redeemable.
4.2 Income tax relief 6/11
4.2.1 Tax reducer
Individuals can claim a tax reducer (see earlier in this Text) of the lower of:
(a) 30% of the amount subscribed for qualifying investments and (b) The individual’s tax liability for the year.
A claim for EIS relief in respect of shares issued by a company in a tax year must be made by the fifth anniversary of the normal self-assessment filing date for the tax year (ie by 31 January 2022 for an investment made in 2015/16).
4.2.2 Limit for relief for investors
The annual maximum for EIS investments qualifying for income tax relief is £1,000,000, but individuals can invest in excess of this amount if they wish.
The investor may claim to have all or any of the shares treated as issued in the previous tax year. When carrying back relief, relief given in the previous year must not exceed overall EIS limit for that year.
4.2.3 Withdrawal of relief
Shares must be held by an investor for at least three years if the income tax relief is not to be withdrawn or reduced if the company was carrying on a qualifying trade at the time of issue. For companies which were preparing to trade at the time of issue, the minimum holding period ends when the company has been carrying on a qualifying trade for three years.
The main reason for the withdrawal of relief will be the sale of the shares by the investor within the three year period mentioned above. The consequences depend on whether the disposal is at arm’s length or not:
(a) If the disposal is not a bargain at arm’s length the full amount of relief originally obtained is withdrawn.
(b) If the disposal is a bargain at arm’s length there is a withdrawal of relief on the consideration received. As the relief was originally given as a tax reduction, the withdrawal of relief must be made at the same rate of tax.

Ted makes a £60,000 EIS investment in 2015/16. His income (all non-savings) for the year is £50,520. In 2016/17, Ted sells the shares (an arm’s length bargain) for £50,000. How much EIS relief is withdrawn as a result of the sale of the shares?

£
2015/16
Net income 50,520
Less personal allowance (10,600)
Taxable income
39,920
£
£31,785  20% 6,357
£8,135  40% 3,254
9,611
Less EIS relief: £60,000  30% = £18,000, restricted to (9,611)
Income tax liability Nil
The effective rate of EIS relief is  100 = 16.018%
2016/17
The sale of the shares for £50,000 as a bargain at arm’s length results in the withdrawal of income tax relief in 2015/16 of £8,009 (ie £50,000  16.018%).

June 2011 Question 4(b) Capstan concerned the sale of shares in respect of which EIS relief had been claimed. The examiner commented that ‘Almost all candidates identified the claw back of the relief if the shares were sold within three years of the acquisition. However, many stated that the whole of the relief obtained would be withdrawn as opposed to a proportion of it.’
Exam focus point Although the company must be unlisted when the EIS shares are issued, there is no withdrawal of relief if the company becomes listed, unless there were arrangements in place for the company to cease to be unlisted at the time of issue.
There are anti-avoidance rules to prevent an individual extracting money from the company without disposing of their shares. However, the rules do not apply where the amount is of an insignificant value (eg any amount of £1,000 or under) or if the receipt is returned without unreasonable delay.
4.3 CGT reliefs
Where shares qualify for income tax relief under the EIS there are also special rules that apply to those shares for capital gains purposes:
(a) Where shares are disposed of after the three year period any gain is exempt from CGT. If the shares are disposed of within three years any gain is computed in the normal way.
(b) If EIS shares are disposed of at a loss at any time, the loss is allowable but the acquisition cost of the shares is reduced by the amount of EIS relief attributable to the shares. The loss is eligible for relief against general income (see later in this Text).

During 2014/15 Martin invested £35,000 in EIS shares and received relief against income tax of £35,000  30% = £10,500.
The shares are sold in February 2016 for £15,000. This will lead to a withdrawal of EIS relief of £15,000  30% = £4,500. What is the allowable loss for CGT purposes?

£ £
Disposal proceeds 15,000 Less: cost 35,000
EIS relief (10,500 – 4,500) (6,000) (29,000)
Allowable loss (14,000)
If the shares had instead been sold outside the three year relevant period (ie so that there was no withdrawal of income tax relief), the allowable loss would instead be: £ £
Disposal proceeds 15,000
Less: cost 35,000
EIS relief (10,500) (24,500)
Allowable loss (9,500)

EIS reinvestment relief may be available to defer chargeable gains if an individual invests in EIS shares in the period commencing one year before and ending three years after the disposal of the asset (see later in this Text).
5 The seed enterprise investment scheme (SEIS)
The seed enterprise investment scheme (SEIS) is a scheme similar to the EIS scheme but rewards investment in small, start-up unquoted trading companies with a more generous tax reducer.
Key term
5.1 Conditions for relief
Individuals who subscribe for SEIS shares are entitled to similar income tax relief (although at a more generous rate) as subscribers for EIS shares but the conditions that the company and investor must satisfy are slightly different.
5.1.1 The investor
The investor must not be an employee of the company, but can be a director. This condition must be satisfied during the period starting with the issue of the shares and ending on the third anniversary of the date on which the shares are issued.
The investor must not be connected with the company. Connection can broadly occur through employment or owning more than 30% (including holdings of associates ie spouse/civil partner or child, but not a brother or sister) of the issued ordinary share capital, issued share capital or voting power of the company or a subsidiary. This condition must be satisfied during the period starting with the incorporation of the company and ending on the third anniversary of the date on which the shares are issued.
5.1.2 The company
To obtain the relief, the following conditions must be satisfied in respect of the company:
(a) The company must be unquoted (eg not listed on a recognised stock exchange), have a permanent establishment in the UK, and meet the financial health requirement of not being in difficulty.
(b) The total value of the company’s gross assets must not exceed £200,000 immediately before the issue of the shares.
(c) The company must have fewer than 25 full-time employees on the date of the share issue.
(d) The company must not have raised more than £150,000 from SEIS investments in a three-year period.
(e) The funds raised must be used by the company, or a 90% subsidiary, to carry out a new qualifying trade. The meaning of qualifying trade is the same as that for the EIS and excludes dealing in land and property backed activities, financial activities, and providing legal or accountancy services. A new qualifying trade is one which has been carried on for less than two years at the date of issue of the shares. The company must not have carried on any other trade before this new trade.
(f) The funds must be used within three years of the issue of the shares.
From 18 November 2015, there is a lifetime cap of £12 million on the total amount of investment a company may receive under the EIS, SEIS and VCT rules.
5.1.3 The shares
The share requirements are the same as for EIS investments, ie the investor must subscribe in cash for new ordinary shares for genuine commercial reasons, although shares with limited preferential rights to dividends can still be qualifying shares.
5.2 Income tax relief
5.2.1 Tax reducer
Individuals can claim a tax reducer (see earlier in this Text) of the lower of:
(a) 50% of the amount subscribed for qualifying investments and (b) The individual’s tax liability for the year.
A claim for SEIS relief in respect of shares issued by a company in a tax year must be made by the fifth anniversary of the normal self-assessment filing date for the tax year (ie by 31 January 2022 for an investment made in 2015/16).
5.2.2 Limit for relief
The annual maximum SEIS investments qualifying for income tax relief is £100,000 (ie the maximum tax reducer is £50,000).
The investor may claim to have all or any of the shares treated as issued in the previous tax year.
When carrying back relief, relief given in the previous year must not exceed overall SEIS limit for that year.

In 2015/16 Arthur invested £40,000 in a qualifying EIS company, and £20,000 in a qualifying SEIS company. He had pension income of £130,000 in 2015/16. Calculate Arthur’s income tax liability for 2015/16. He does not wish to treat any shares as issued in 2014/15.

£
2015/16
Taxable income (no personal allowance)
130,000

£31,785  20% 6,357
£98,215  40% 39,286
45,643
Less EIS relief: £40,000  30% (12,000)
Less SEIS relief: £20,000  50% (10,000)
Income tax liability 23,643
Remember that if the individual is entitled to more than one investment tax reducer, the VCT reducer is deducted first, then the EIS reducer and finally the SEIS reducer (see earlier in this Text).

5.2.3 Withdrawal of relief
As for EIS, shares must be held by an investor for at least three years if the income tax relief is not to be withdrawn. Where the disposal is a bargain at arm’s length, the amount withdrawn will usually be 50% of the amount received for the shares (as for EIS relief it will be less if full relief was not given because the taxpayer’s tax liability was less than the amount subscribed for). Where the disposal is not at arm’s length, the whole of the relief given is withdrawn.
Although EIS and SEIS investments carry attractive tax reliefs remember that they are high risk investments.
Exam focus point
5.3 CGT reliefs
Where shares qualify for income tax relief under the SEIS there are also special rules that apply to those shares for capital gains purposes in the same way as for EIS shares (see section 4.3 above).
There is a SEIS reinvestment relief where an individual makes a gain in a tax year and also invests in SEIS shares in the same tax year. This relief is dealt with later in this Text.
6 Venture capital trusts (VCTs) 6/12
Venture capital trusts (VCTs) are listed companies which invest in unquoted trading companies and meet certain conditions.
Key term
6.1 Conditions for relief
Individuals who subscribe for VCT shares are entitled to both income tax and capital gains tax reliefs where certain conditions are satisfied.
6.1.1 The investor
The VCT scheme differs from EIS as the individual investor invests directly in a quoted VCT company that itself invests in higher risk unquoted companies. The investor therefore spreads their risk.
6.1.2 The company
A Venture Capital Trust is a company, whose shares are admitted to trading on a regulated European market, that invests in small unquoted EIS-type companies.
To be HMRC approved, a VCT must satisfy (and continue to satisfy) the following conditions:
(a) Its income comes wholly or mainly from shares or securities.
(b) At least 70% of its investments are in shares in qualifying holdings. Qualifying holdings are broadly holdings in unquoted companies carrying on qualifying trades in the UK.
(c) At least 70% of its holdings must be in ordinary shares and no one holding can amount to more than 15% of its total investments.
(d) It has not kept more than 15% of its income from shares and securities ie it must distribute 85% of its income from shares and securities.
The companies invested in must have fewer than 250 full-time employees (or their equivalents) on the date of the share issue.
The money invested in a company by the VCT must be used wholly for the purposes of the company’s qualifying trade within two years. From 18 November 2015, the company cannot use money invested by the VCT for a takeover of another company or the acquisition of an existing trade.
From 18 November 2015, the VCT must usually make an investment in a company which either is no more than seven years old or, if it is more than seven years old, must have raised qualifying funds in its first seven years. An investment may be made after this time if the amount of the investment is at least 50% of the annual turnover of the company, averaged over the previous five years.
The gross assets of the company invested in must not exceed £15m prior to nor £16m after the investment. The company must not have raised more than £5m in venture capital schemes in the 12 months ending on the date of the investment.
The companies invested in must have a permanent establishment in the UK at all times from the issue of the VCT shares to the time in question.
The companies invested in must meet the financial health requirement when the VCT shares are issued.
From 18 November 2015, there is a lifetime cap of £12 million on the total amount of investment a company may receive under the EIS, SEIS and VCT rules.
6.2 Tax reliefs
An individual investing in a VCT obtains the following tax benefits on a maximum qualifying investment of £200,000:
• A tax reducer (see earlier in this Text) of the lower of 30% of the amount invested and the individual’s income tax liability for the year.
• Dividends received are tax-free income.
• Capital gains on the sale of shares in the VCT are exempt from CGT (and losses are not allowable).
6.3 Withdrawal of relief
If the shares in the VCT are disposed of within five years of issue the following consequences ensue:
• If the shares are not disposed of under a bargain made at arm’s length, the tax reduction is withdrawn.
• If the shares are disposed of under a bargain made at arm’s length, the tax reduction is withdrawn, up to the disposal proceeds  30%.
If a VCT’s approval is withdrawn within five years of the issue, any tax reduction given is withdrawn.
Note that there is no minimum holding period requirement for the benefits of tax-free dividends and CGT exemption.
Chapter roundup
• An employee may be entitled to join their employer’s occupational pension scheme. Both employees and the self employed can take out a ‘personal pension’ with a financial institution such as a bank or building society.
• An individual can make tax relievable contributions to their pension arrangements up to the higher of their earnings and £3,600. Contributions to personal pensions are paid net of basic rate tax. Employers normally operate ‘net pay’ arrangements in respect of contributions to occupational schemes.
• Employers may make contributions to pension schemes. In certain circumstances employers contributions are spread over a number of years.
• The annual allowance is the limit on the amount that can be paid into a pension scheme each year. If this limit is exceeded there is an income tax charge on the excess contributions. Unused annual allowance can be carried forward for up to three years.
• An annual allowance charge arises if tax-relievable contributions exceed the available annual allowance.
• An individual can start to receive pension benefits from the age of 55. Under flexible access drawdown, a tax-free lump sum of 25% of the pension fund can be taken and the remainder reinvested to give taxable pension income as required.
• The maximum value that can be built up in a pension fund is known as the lifetime allowance.
• The enterprise investment scheme, seed enterprise investment scheme and venture capital trusts are designed to help unquoted trading companies raise finance.
Quick quiz
1 What are the two types of occupational pension scheme?
2 What is the maximum lump sum that can be taken on retirement (lifetime allowance not exceeded)?
3 What is the limit on contributions to an registered pension scheme?
4 What are the consequences of the total of employee and employer contributions exceeding the annual allowance?
5 What are the consequences of exceeding the lifetime allowance?
6 What income tax relief is available in respect of investments under the enterprise investment scheme for investments in 2015/16?
7 What is the maximum tax reducer available for investment by an individual under the seed enterprise investment scheme in 2015/16?
Answers to quick quiz
1 Occupational pension schemes may be final salary schemes or money purchase schemes.
2 25% of the fund.
3 Higher of relevant earnings and the basic amount (£3,600).
4 The excess is subject to the annual allowance charge on the employee. (Any contributions by the employee which were not eligible for tax relief are ignored.)
5 The excess is charged at 55% (if taken as a lump sum) or 25% (if taken as a pension).
6 EIS income tax relief is tax reducer up to 30% of amount subscribed up to £1,000,000.
7 £100,000  50% = £50,000.

Number Level Marks Time
Q2 Introductory 16 31 mins

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