Introduction – top ten types of tax structures for 2020
The UK has a myriad of different types of tax structures. These are invariably taxed in different ways meaning it may be more tax efficient to enter into a commercial transaction or an investment through a particular entity.
In addition, there are various Government reliefs and initiatives which may also turn some of these types of tax structures into tax efficient options. Usually, these require an activity or the entity (and sometimes both) to meet certain conditions.
In short, tax efficient structures do not usually come without great responsibilities!
Let’s look at the top ten types of tax structures.
Enterprise Investment Scheme (“EIS”) and Seed EIS
EIS investments are not self-contained tax efficient structures in themselves – but simply a Company which meets various qualifying conditions and, usually, has applied for various clearances and gone through an administrative process with HMRC.
If one subscribes in cash for new shares in a Company which qualifies under the EIS scheme then one may benefit from the following trio of reliefs:
- CGT deferral relief: Where one has suffered a capital gain in the last three years (or expect to incur one in the next 12 months) then, if one reinvests that gain, the tax liability can be deferred until the sale of the shares) or the investment ceases to qualify if it does so within three years). The amount of the gain that may be deferred is unlimited;
- Income tax relief: If one subscribes for shares in a company and that holding qualifies then one may receive income tax relief of up to 30% of a maximum investment of £1m. Again, the shares must qualify for the three-year holding period;
- CGT exemption relief: subject to the shares qualifying for the three-year holding period, then a sale of EIS shares are exempt from CGT.
Practically speaking, CGT deferral relief may be obtained on the reinvestment in one’s own company, even if one holds 100% of the shares.
However, for the other two reliefs, the investor cannot be connected. Amongst other things, this means they cannot hold more than 30% of the equity in the Company.
The shares issued must be in a trading company and cannot participate in an excluded activity. Generally speaking, this excludes asset backed businesses such as property development and care homes. However, historically, pub businesses have been popular and more recently childcare nurseries – both of which are ‘asset backed’. Other types of activity are also blacklisted.
The size of the Company is also restricted.
There are many other conditions which must be met which are outside of the scope of this article. However, when looking at the different types of tax structures, even by the standards of tax efficient structures, one must proceed with extreme care in this area.
Seed EIS is EIS’ little brother. It is a more generous relief in that, for income tax purposes, it allows tax relief of 50%. However, one can only invest £100k in a Seed EIS company and the amounts a Company may raise are much reduced. Seed EIS is only available to small, start-up Companies.
Venture Capital Trust (“VCT”)
A VCT is a investment company that is listed on the London Stock Exchange. They are set up to facilitate investment in to small UK businesses. The type of business that a VCT can invest in is subject to a number of conditions.
As with EIS and Seed EIS discussed above, the Government provides attractive tax breaks to encourage investment in these businesses. As with most types of tax structures offering tax efficient benefits, there is an ulterior motive behind the provision of the reliefs. The tax relief acts as a carrot. In the case of EIS and VCTs it is to encourage investment in what are higher-risk companies. As such, these types of tax structures are not for the feint hearted.
Figures for the tax year 2015/16 indicate that Investors invested £458 million into VCTs. This was the largest amount for ten years.
Where an individual invests in new VCT shares, then they are eligible to claim another trinity of tax reliefs. Relief is capped and available on a maximum investment of £200,000 in each tax year.
This trio of tax reliefs is as follows:
- Income tax relief: Similar to the EIS scheme, you can claim up to 30% income tax relief on the amount you invest. This tax relief is deducted as a credit from your income tax liability. This is conditional on the fact that have retained the VCT shares for at least five years.
- Tax exemption on capital gains: On the sale of the VCT shares at a profit the capital gain is free of CGT;
- Tax exemption on dividends – Where the VCT pays you dividends then there is no tax to pay on these receipts.
As a VCT is a listed company, then its shares are traded on the London Stock Exchange. As such, a VCT must:
- Prepare and publish an annual report and financial accounts;
- It must install an independent Board of Directors;
- Conduct general meetings for shareholders, including an Annual General Meeting (AGM).
- Meet the governance standards in the same manner as any other public company.
Business Investment Relief (“BIR”)
We move on to number three in our countdown of types of tax structures.
BIR is a relief that is available UK resident, but non-UK domiciled individuals (non-doms). In our view, it is a bit of a hidden gem.
The relief is relevant to those non-doms who pay tax on the remittance basis. As you may be aware, this basis of taxation affords non-doms the privilege of holding their foreign income and gains offshore and, whilst it stays offshore, then there is no UK tax liability.
However, if they choose to bring those funds to, or otherwise enjoy in, the UK (known as a ‘remittance’) then the underlying income and gains will generally be taxable.
It may seem slightly strange that the UK encourages wealthy non-doms to the UK by providing them with a generous tax framework – only to then discourage them from bringing their overseas funds into the Country!
BIR acts to try and unlock that offshore wealth by allowing non-doms to use that ‘idle’ money (from a UK perspective) in the UK. However, it must take the form of a qualifying UK commercial activity.
The form of the investment is actually quite flexible. This is in contrast to most tax efficient structures where conditions tend to be highly prescriptive. For example, the qualifying conditions for BIR are much less onerous than for EIS and / or Seed EIS.
The investment must be made into a limited company. However, the investment can take the form of either equity or debt.
A company must be able to slot into one of the following three categories:
- Eligible trading company: A Company whose activities (or substantially all of its activities) are carrying on or preparing to carry on a commercial activity (including renting property) or carrying out research and development;
- Eligible holding company: A company that holds in excess of 51% of the shares in one or more eligible trading companies;
- Eligible stakeholder company – a private limited company that’s purpose is the making of investments in eligible trading companies.
The target company must use the investment in a qualifying trade within two years.
A handy feature of the regime is the ability to obtain advance clearance from HMRC in respect of a proposed investment.
Ultimately, in the context of the different types of tax structures, a pension scheme is a very tax efficient structure. It is, of course, the case that a pension scheme is ultimately there to provide a person or persons with benefits in retirement. As such, the generous tax benefits which apply to the scheme are the carrot to make one provide for older age.
Over the last few years, the tax advantages of pension schemes have been eroded – especially for wealthier taxpayers.
A pension scheme is usually a trust based tax efficient structure although you will sometimes find contract based schemes.
Most of the tax benefits afforded to pension schemes are only available to UK registered pension schemes. Rather intuitively, this is a pension scheme which has applied for, and gained, registration with HMRC.
So, what flows from this registered status?
Well any contributions to the scheme are likely to obtain some form of tax relief. Whilst contributions can be made without any limits, the amount of tax relief available will be capped.
For an individual, the basic position is that they can obtain tax relief on the greater of 100% of their earnings or £3,600. However, there is then another limit, called the Annual Allowance, which will act to claw-back any relief over the threshold. This is now set at £40k and is well below historic limits which have been in excess of six times this amount. This limit is also reduced where the individual earns more than £150k.
Generally speaking, an employer can contribute as much as it likes to a scheme for its employees. However, don’t forget that any contribution must be ‘wholly and exclusively’ for the purposes of the trade under general principles in order for the business to be able to deduct this contribution from its profits.
Once there are funds in the pension scheme, it will also usually benefit from income tax and capital gains tax-free growth – although there are some exceptions. A pension scheme may normally invest in any assets it sees fit. However, there are some assets which trigger a tax charge under the taxable property rules. For instance, where a scheme invests in residential property – directly or indirectly – it will usually result in a tax charge.
When it comes to taking benefits from the scheme, usually from age 55 onwards, then up to 25% can usually be taken as tax-free cash and the balance can be taken as a taxable pension income.
Individual Savings Accounts (ISAs)
Many people will be familiar with ISAs in the context of types of tax structures as they are a tax efficient structure that has displayed a high degree of longevity.
Essentially, an ISA is a savings account on which you don’t pay income tax on. You can save up to a total of £20,000 in the 2019/20 tax year and this can be split between a cash ISA , a stocks & shares ISA, what’s known as an innovative finance ISA and a Lifetime ISA as you see fit.
Whilst funds are retained within the ISA wrapper then any returns will continue to be paid without any liability to tax.
As stated above, there are five main types of ISAs:
- Cash ISAs: Broadly speaking, a cash ISAs is simply savings account where the interest paid is not subject to tax where the interest.
- Help to Buy ISAs: No new accounts have been possible after 20 November 2019. If you already have such account then you can continue to invest in to it until 30 November 2029.
- Innovative finance ISAs: This type of ISA can allow one to invest in a number of alternative forms of finance including peer-to-peer lending and crowdfunding. In many ways, it seems like an accident waiting to happen!
- Stocks & shares ISAs: This allows you to invest in stocks and shares via the ISA wrapper. Investing in such assets through an ISA provides three tax advantages:
- Tax-free disposals: There is no capital gains tax on profits made on a sale of the shares.
- No tax on any bond interest.
- No tax on dividend income from shares.
- Lifetime ISAs (“LISA”): These were launched on 6 April 2017 and allow you to save up to £4k per year into the LISA. The Government will supplement this with a 25% bonus.
QNUPS & QROPS
We talked about registered UK pensions above as one of the types of tax structures. We now move overseas. In this regard, the statutory tax reliefs start to fade away, however, this perhaps brings with it extra flexibility.
So, first of all, what is a QNUPS. Well, in the pantheon of great acronyms a QNUPS is short hand for Qualifying Non-UK Pension scheme. A QNUPS is not a registered pension scheme however it does benefit from recognition by HMRC.
The QNUPS definition is found in the IHT legislation. It provides that an overseas pension scheme that meets the definition is afforded with an IHT exemption, so assets within a QNUPS should be outside of the estate of any person. Furthermore, a QNUPS is not what is called ‘relevant property’ (see below re trusts) meaning that there is no entry charge, 10-year charge or exit charge.
It should be possible to transfer assets to a QNUPS without incurring an IHT charge assuming that the contribution is made for genuine retirement reasons. Alternatively, assets could be sold or loaned to the QNUPS without an immediate IHT charge.
Capital Gains Tax is more likely to be an issue where chargeable assets (cash is not chargeable) are transferred and those assets stand at a capital gain.
Assets within the trust do not benefit from a statutory exemption from income tax, as is the case for a registered pension scheme. However, careful structuring and dependant on the assets held, efficiency in this regard could be achieved.
The statutory exemption for capital gains tax should be available for QNUPS. As such, this could be a useful vehicle for holding UK residential property for a wide range of clients. Of course, other taxes need to be considered.
Assets within a QNUPS are not covered by the taxable property rules so there are no penal tax charges on investing in any type of property. As referred to above, this means a QNUPS could invest in residential property.
The second of our acronyms, QROPS, stands for Qualifying Recognised Overseas Pension Scheme. Again, this is a recognised overseas pension scheme and, as such, is regulated in the country of its establishment.
Historically, any transfer that is made from a UK-registered pension scheme to a QROPS has been a ‘recognised transfer’ which means that no tax penalty has been imposed.
Although a QROPS is not technically a registered pension scheme, many of the restrictions and penalty regimes will continue to apply. For instance, a QROPS cannot invest directly or indirectly in residential property without a large tax penalty.
However, following recent surprise rule changes, any transfers taking place since March 2017, a new regime has applied. If the funds in a UK registered scheme are transferred to a scheme based in another EEA state, or the member is resident in the same jurisdiction as the receiving scheme then the position remains the same – there is no charge. However, where this is not the case, then the transfer will usually result in a 25% tax charge.
As such, a QROPS may benefit you where you are currently resident outside of the UK are planning to become an expatriate in the future.
The second group of people who might benefit are those who are approaching the Lifetime Allowance. A transfer of a registered pension scheme to a QROPS is a Benefit Crystallisation Event meaning it is tested against the Lifetime Allowance. As such, this could result in a tax charge where the transfer exceeds the individual’s Lifetime Allowance.
However, in respect of a QROPS transfer, this is the only time the scheme is likely to be tested against the Lifetime Allowance.
As such, for those approaching the Lifetime Allowance, exploring the use of a QROPS might make sense as their pension scheme can grow free of any concern of exceeding the lifetime allowance threshold.
To many, trusts bring visions of tax avoidance and other fiscal black magic. However, realistically, UK trusts have long since ceased to provide any significant tax benefits.
Instead, one should think of a trust as asset protection structures rather than as tax efficient structures.
A trust is a means of controlling what happens to the capital of an asset when given away. A gift with strings attached, as it were. Essentially, the tax position crystallises once one moves to make the gift. The attaching of the strings gives little tax benefit and, in fact, is likely to bring with it adverse tax consequences.
Virtually all new trusts set up since March 2006 will be subject to the relevant property regime. This means that where the value of assets entering the trust exceed the nil rate band (currently £325,000) then there will be an immediate 20% IHT charge on the excess. Death within seven years of the transfer would result in a further 20% being chargeable which would put this in the same position as an outright gift where one died within seven years.
Assets qualifying for Business Property Relief (“BPR”) can allow transfers in excess of the nil rate band into a trust without an immediate tax charge. Care should be taken as if the settlor dies within seven years and the assets have been sold then there will be a clawback of relief.
The transfer to a trust is a disposal for CGT purposes. However, as long as the trust is not settlor interested, it is usually possible to ‘hold over’ any gain. This means the gain is passed on to the recipient as a condition of the gift.
The distinction between Interest in Possession (“IIP”) trusts and Discretionary trusts (“DTs”) becomes germane for income tax purposes. A DT is usually inefficient for income tax purposes – albeit its greater asset protection properties will mean this creates a dichotomy for those looking at family wealth solutions.
As such, a UK trust should be seen as a sensible way of making a gift but retaining control rather than in the toolkit of types of tax structures per se.
The announcement and implementation of a UK trusts register will perhaps fetter the use of trusts for privacy purposes.
Similarly, to UK trusts, offshore trusts have increasingly found themselves linked with negative connotations – secretive Swiss banking, Panama Papers etc.
Again, however, the truth is that the use of offshore trusts, far from being a magic tax-free bucket the press wish us to believe, also presents limited tax planning opportunities for UK resident and domiciled individuals. This is as a result of the slew of anti-avoidance measures in this area.
Offshore trusts can still be tax efficient structures for either non-UK domiciled individuals or for non-UK residents.
In addition, overseas alternatives such as foundations might be of interest to the more complex client when looking at asset protection and tax efficient structures.
Of the various types of tax structures, employer trusts have had a bad rap over the years as they have been aggressively used for corporation tax and income tax planning. Often referred to as ‘disguised remuneration’. As such, HMRC has pursued this use of them just as aggressively. Not one of the tax efficient structures you might think we should be promoting?
However, employer trusts are, as one of the types of tax structures, creatures of statute and they do provide other valuable reliefs if one forgets the more egregious historical uses.
Employer trusts are trusts which are set up by an employer – usually a Company – for the benefit of its employees. This is the fundamental difference between this and a private trust which is usually established by an individual or family.
However, an employer trust is extremely tax efficient from a capital taxes perspective. Capital taxes usually means Inheritance Tax (“IHT”) and capital gains tax (“CGT”).
From an IHT perspective, there are statutory reliefs that prevent transfers to the structure being ‘transfers of value’ for IHT purposes. In other words, they are ‘non-events’ for IHT. Broadly, these reliefs will apply where an individual or individuals are transferring a controlling shareholding to a qualifying trust. In addition, a company can transfer some of its assets to such a trust without an IHT liability.
Where the IHT relief applies, it generally follows that the transfer will escape a CGT charge as well under a mirroring capital gains tax relief. The application of the relief means the assets are transferred at a value which results in no gain, no loss.
The trust is not related property so there is no ten-year charge and there is no ‘traditional’ exit charge. However, the employer trust regime has its own version of the latter which needs to be managed.
As such, forgetting the negative baggage that they carry, these can still be useful tax efficient structures in the right circumstances.
Employee Ownership Trusts (“EOT”)
We reach our tenth and final entry in our list of top ten types of tax structures. The relatively new EOT.
An EOT is a special trust to which you can sell some or all of the shares you own in your trading company. Due to the special CGT status, you can do this without triggering a taxable gain. As such, this is even more attractive than Entrepreneurs’ Relief.
As the name suggests, the beneficiaries of this trust will be your Employees.
The Government introduced these tax efficient structures in September 2014 to encourage more shareholders to set up structures facilitating employee ownership reflecting that beacon of employee ownership called John Lewis.
As one would expect, where generous reliefs are available, the qualifying conditions are pretty tight.
There are generally three key stages to an EOT:
- The EOT is established, taking care that the qualifying conditions are satisfied.
- The existing shareholders in the business sell their shares to the trust. The shares are sold to the trust at market value. Usually, the consideration is left outstanding.
- The company will hopefully continue on its merry profitable way. It will use these profits to make contributions to the EOT, which will in turn use these contributions to repay the outstanding purchase price that it owes to the vendor shareholders.
Of course, an EOT puts employees into a position where they can indirectly buy the business from its shareholders. However, they do not have to use their own funds. This should assist with succession planning issues.
The directors can remain in place following the sale to the EOT. It is quite acceptable for them to receive a market rate remuneration package.
ETC Tax can advise on the various types of tax structures.
None of the above types of tax structures is the magic bucket where, if one places his or her assets or income, one’s tax exposure suddenly vanishes. Sadly, no such device exists.
However, the Government does present its taxpayers with a variety of carrots to encourage certain behaviours. Some of these reliefs can be rather attractive. However, generally they come with a number of qualifying conditions which can tie one in knots.
We can assist with all aspects of tax structures, Government reliefs and initiatives. Our services, among others, include:
Contact us for a no-obligation initial conversation about the types of tax structures with an experienced tax adviser.