Thursday, 12 April 2012

Enterprise Investment Schemes and private school fees

*** All references to tax relief in this post are accurate at time of writing. ***

Both Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCT) are becoming more important and certainly more prominent for people looking to plan for long term school fees.

Like ISAs and Pensions, EIS and VCT both long standing investments carry significant tax relief. In all honesty it is not too difficult to argue that they are actually better in certain circumstances than ISAs or pensions.

As always it is important to receive good quality financial advice before considering any investment.

How these little beauties help with school fees is of course not for everyone but in certain circumstances they can make a massive difference (reduction) in the overall cost of private education.

To start with, both receive tax relief at 30% but crucially this is not (unlike pensions etc) restricted to your marginal rate of income tax.

You can claim relief up to the amount of tax you have actually paid which makes this insanely efficient for basic rate tax payers that have either significant cash reserves or possibly for a husband and wife where one partner provides the majority of the household income and the other  just a small additional amount.

Let me give you an example:
Mr Jones earns £38,105
Personal allowance £8,105 (2012 / 2013)
Taxable income £30,000
Tax due £6,000

In addition Mr Jones has an £80,000 inheritance

For an investment of £20,000 into an EIS Mr Jones would receive relief of £6,000. Unlike with a pension though this relief is paid back to Mr Jones, not added to the investment meaning Mr Jones will have paid no income tax for the year, will have a £20,000 EIS investment and have an additional £6,000 to go toward his school fees etc.

There are many more additional benefits such as IHT relief after 2 years and capital gains rollover relief both of which go to make an EIS incredibly tax efficient.

Mr Jones repeats the above investment for the subsequent 3 years meaning he has invested all of his £80,000 and paid little to no income tax for 4 years.

In order to fully qualify for the tax relief an EIS must be held for 3 years from production of the investment certificate. In practical terms this can take some time so for safety sake it is best to assume 4 years instead of 3. Once you investment has passed the 3 qualifying years you are able to dispose of the investment and then reinvest it in another EIS which attracts a further 30% tax relief.

Using the example above it would mean that for Mr Jones, in year 5 he uses the proceeds from his year 1 investment to attract a further 30% relief. That could mean that Mr Jones receives a further £6,000 relief on the same £20,000 investment. The net cost to him would at that point be £8,000 (£6,000 relief in year 1 and a further £6,000 relief in year 5). In year 9 the cost of investment, given a further £6,000 relief would mean the actual real investment cost would be only £2,000.

In year 6 he uses the year 2 investment
In year 7 he uses the year 3 investment
In year 8 he uses the year 4 investment
In year 9 he uses the year 1 & 5 investment

and so on....

If you haven't already got it this means that for £80,000 Mr Jones has reduced his income tax bill completely and potentially indefinitely and has also received an annual £6,000 contribution towards his school fees.

I appreciate given school fees inflation and the current cost of school fees £6,000 is only a small contribution however it comes 100% from HMRC from money that would otherwise have been lost as tax...

There is a lot of talk at present about the super wealthy in the UK getting away with paying little to no tax. However, I hope you would agree that this is close if not quite exactly the sort of situation many millions of people are in the UK and benefits them far more than any tax relief the super wealthy receive; in effect, a 150% tax relief on income...

*** All references to tax relief in this post are accurate at time of writing. If when reading this post it is significantly (over a year approx) old then please double check the tax relief status on the types of investment mentioned. Your financial adviser should have absolute up to date information about the investments ***