How to get tax relief when investing

8 May 2012

In this age of austerity, the government isn't offering many handouts, which is all the more reason to snap them up where they still exist.

Investing through a tax-efficient vehicle, such as an ISA, pension, venture capital trust (VCT) or enterprise investment scheme (EIS), can give a significant boost to an investment portfolio, but they have to be used judiciously and blended with an appropriate investment strategy to give the best outcome.


ISAs and pensions will usually form the core of any investment portfolio. ISAs offer huge investment flexibility, and all income and capital gains are free from further tax, although the 10% tax at source on share dividends paid within ISA funds cannot be reclaimed.

For higher-rate taxpayers, income tax rates are more than double those for capital gains tax (CGT), so it can make more sense for them to put income-generating investments such as equity income funds or corporate bonds into their ISA. In this way, they can generate a long-term, tax-free income stream.

Income from a pension, in contrast, is taxable, but investors get tax relief on their initial investment. The key advantage of a pension is that it is very long term and all capital gains are free from tax. This allows investors to take greater risks and therefore perhaps look at investment areas such as emerging markets or smaller companies, which are more volatile but may have higher growth characteristics over the long term.

ISA versus pensions: which is best?

Self-invested personal pensions (SIPPs) allow greater investment flexibility than conventional pensions and investors can build a more personalised portfolio.

David Jeal, product manager at Selftrade, says: "Either income or growth can be efficiently held in an ISA or SIPP, although income-generating stocks might seem the more obvious ISA choice in terms of avoiding income tax, and they could also be a good choice for your later years when income becomes a priority in retirement.

It is worth reinvesting dividends in the early stages as the effects of compounding can be very beneficial.

"ISAs can't hold gilts and bonds with less than five years to maturity at the time of purchase, nor can they hold small-cap stocks listed on the Alternative Investment Market (AIM) or the PLUS Stock Exchange."

Jeal adds that investors should not forget about regular investing into ISAs and SIPPs.


For those interested in investing in the UK's small companies, there are some extremely tax-efficient options. Danny Cox, head of advice at Hargreaves Lansdown, says: "VCTs are a highly tax-efficient way to invest in some of the most dynamic, entrepreneurial, high-growth companies.

However, they are inherently high risk. They are long-term, speculative investments but they give you the chance to get in on the ground floor of fledgling investment opportunities. Tax relief is available up to 30%, meaning a £10,000 investment might cost as little as £7,000."

Investors can put up to £200,000 a year in a VCT and receive income tax relief on the entire amount, although they cannot receive more in rebates than has been paid in income tax. When the holdings are eventually sold, any gains made are free from CGT, providing they have been held for more than five years. Any dividends received are also free from tax.

There are three main types of VCT: limited life, specialist and generalist. Limited life VCTs tend to be lower risk, looking for an exit within, say, five years. Specialist VCTs focus on just one sector, often technology. Generalist VCTs will invest across a variety of businesses.

Performance has been mixed, with some VCTs providing good returns to investors over and above the income tax incentives, and some still losing money in spite of generous reliefs. Cox recommends the Matrix Linked Offer, Downing Income III and Edge Performance H Share for this tax year.


The tax reliefs available on an EIS are even more generous than those on a VCT. EISs invest in similarly small, start-up style companies, so they are also high risk. The tax relief on an initial investment into an EIS is also 30% but investors can put in between £500 and £1 million, potentially getting rid of their entire income tax liability for a year.

There is also the potential to defer capital gains made on a separate investment by reinvesting them into an EIS. The reinvestment has to meet certain criteria - disposal of the original asset has to be less than 12 months before the EIS investment or less than 36 months after it.

In this way, gains can be deferred until a tax year in which you are not using your CGT allowance, or have retired and are paying lower tax rates anyway.

For the EIS investment itself, no CGT is payable if you sell the shares after three years, provided the EIS initial income tax relief was given and not withdrawn on those shares. Any losses on EIS shares can be set against your capital gains or income tax liability in the year of disposal.

Investors can find out about investment opportunities through the Enterprise Investment Scheme Association ( IFA Allenbridge also offers analysis of the latest EIS opportunities (, and there is more useful information on EISs and VCTs on the Clubfinance website (

The companies eligible for EISs have to be worth less than £7 million, and individual investors can have up to 30% stake in the business, so these schemes are not for widows and orphans.

However, the tax breaks mitigate some of the risks.

There is a tax-efficient investment for every occasion. The ISA limit may only be £11,280 for this tax year (2012/13) but investors can squirrel far more than that away in other tax-incentivised schemes.

There is a danger, however, of letting the tax tail wag the investment dog, so you need to be clear that the investment proposition suits your needs – and if you're going to look to some of the racier tax-avoidance schemes, you need to ensure that you are prepared for a more volatile ride.

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