- With tax liabilities in the spotlight, wealthier investors may consider some lesser-known techniques
- We assess some overlooked options
The prospect of a tightening tax net may well have spurred investors into action, but the most conventional routes to tax-efficiency can have their limits. The £20,000 annual tax-free allowance on Isa contributions will only go so far for wealthier individuals, while frozen thresholds on capital gains tax (CGT) and the pension lifetime allowance only up the pressure. Yet some lesser-known routes to tax efficiency exist. While each comes with its own complications, those who have used up the usual allowances could consider special measures.
Taking it private
As individuals, investors are subject to the usual taxes outside a wrapper, including CGT if and when they exceed a £12,300 threshold (in the current tax year) on realised gains. Yet there are ways to shield some gains from the taxman outside Isas and pensions.
Extremely wealthy individuals could consider setting up their own private open-ended investment company (Oeic), the structure commonly used for open-ended funds. The advantages here relate to any portfolio rebalancing outside a tax wrapper: individuals who have to rebalance a big portfolio in a taxable environment could rack up a CGT bill by simply taking profits on their winners. An Oeic could solve this problem, as any trades within the Oeic structure are not subject to CGT. An investor can only trigger a CGT event by selling the units in the Oeic itself.
Jason Hollands, managing director at wealth firm Tilney, which recently acquired private Oeic provider 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 authorised corporate directors (ACDs), which can appoint one or more investment managers, and investors can turn to the likes of a wealth manager to work on the arrangements.
“If you have a substantial portfolio you need to bear this in mind," says Hollands. "Just day to day or month to month, moves in a portfolio [and rebalancing] could involve crystallising capital gains so you have to be mindful not to exceed your exemption."
The advantages of an Oeic held outside of a tax wrapper are not limited to those with £5m or more to put to work. Investors who hold an Oeic, or even an investment trust, do not incur tax on gains made within the fund’s structure. But gains made when they sell units in the Oeic or shares in the investment trust are subject to CGT rules.
If you are forced to hold funds outside tax wrappers, your choice of investment can make a big difference. Higher-octane picks such as equity funds can be more likely to register 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, as one silver lining, be offset against your other gains for CGT purposes.
The funds most likely to carry out substantial rebalancing tend to be multi-asset funds, which can serve a purpose in a self-directed investor's portfolio. The so-called wealth preservation trusts and funds are one obvious example, given they add a defensive element to your portfolio. Generally these vehicles should make modest gains compared with many equity funds, potentially exposing you to less of a CGT risk if you sell some units or shares.
Investors sometimes use multi-asset vehicles as the core of their portfolio, including fund of funds. These funds could make bigger gains depending on their exposure to equities. Investors may also rely on multi-asset funds for income. These can sometimes have a high reliance on equities, potentially resulting in big gains in good years.
Other solo options
Investors who have substantial assets but not enough to warrant a private Oeic could consider setting up an investment company. This would be cheaper than setting up an Oeic, and would subject the relevant chunk of assets to business rather than personal taxes. But this involves extra work, including making corporate disclosures and putting directors in place, and the tax appeal could vary over time.
Hollands notes that people tend to set up personal investment companies “on the basis that business taxes are lower than personal taxes,” and the relative appeal could change if the chancellor overhauls the current regime. Corporation tax is due to increase from its current 19 per cent rate to 25 per cent in April 2023, but any future rises in personal tax rates, especially CGT, may mean that the corporate route remains attractive. As such, it is worth carefully assessing the potential tax implications of any assets held outside a wrapper. A good tax adviser may be able to outline the pros and cons of this option.
Other options can be extremely complex. Matt Lewis, chartered financial planner at EQ Investors, suggests offshore investment bonds for individuals willing and able to invest for the longer term. These structures can house an investment portfolio, and be issued by life companies in jurisdictions that impose no tax on the income and capital gains of the underlying funds. Assets can be switched within the structure without incurring tax, although the portfolio can be subject to withholding tax levied by the overseas jurisdictions. As Lewis notes, the offshore investment bond structure allows you to “defer” taxation. A chargeable gain will be assessed on income tax, meaning a higher or additional-rate taxpayer could defer this until they have fallen into a lower tax band.
Events such as a death, transfer of ownership or withdrawal beyond a yearly tax-deferred allowance of 5 per cent can trigger a tax event.
While these are options for those who have exhausted their Isa and pension allowances, wrappers remain the first port of call for the majority of investors. Other good practices also remain relevant: taking gains on investments outside a tax wrapper to avoid building up a large CGT liability is one useful step to take, counterintuitive as it might feel. Other portfolio techniques can alleviate your CGT woes. Because the average purchase cost of an investment is used to work out your CGT bill, investing regularly can lessen the potential bill on a holding that keeps making steady gains.
Another method that may go forgotten is the transfer of assets between spouses to take advantage of different tax-free allowances and circumstances.
“The simplest piece of financial planning any couple can do is juggling who owns the assets through interspousal transfers to optimise two sets of allowances,” Hollands notes. “Someone might be subject to lower rates of tax in the form of capital gains or income tax. If you made a big profit on shares, use up your CGT allowance but, before the trade, switch some of the shares or funds to your spouse so they are sold against their CGT exemption. There’s usually no cost to doing it, you just instruct your broker.”
Some of these approaches may be a better way of reducing a tax bill than backing riskier investments such as venture capital trusts (VCTs). But this will always depend heavily on individual circumstances.