Written by FCSA Business Partner, Octopus Investments
A decade on from the Global Financial Crisis and the cupboards remain pretty bare for HM Treasury.
Philip Hammond did use his Autumn Budget to ease back on the government’s unpopular programme of austerity measures. But the books need to balance, so it was no surprise to see a continued focus on measures designed to increase the tax take.
The good news for contractors was that there were no immediate tax increases announced. In fact, the announcement of a two-year freeze on the £85,000 VAT registration threshold will have been well received.
There is, however, one notable cloud on the horizon: the much-anticipated consultation into IR35 (the government’s anti-avoidance legislation designed to tax so-called ‘disguised employment’ at a similar rate to employment) in the private sector. The Budget gave the consultation the go-ahead and it will be published imminently.
As ever, then, it’s important to be aware of the tax allowances and reliefs available to contractors who provide their services through a limited company. These can help contractors make the most of their money.
You should also know what options you have for looking after your cash tax efficiently, as well as options for tax efficient investments. In a moment we’ll look at a couple of options you may not have considered before. First, though, let’s recap on the key allowances and thresholds and how they’re due to change for the 2018/19 tax year.
Allowances and thresholds
Contractor companies’ revenues (less any allowable costs) will continue to be subject to corporation tax at a rate of 19% for the 2018/19 tax year. However, for those contractors earning a salary from their company, the income tax personal allowance is set to increase from 6 April 2018. Contractors will be able to pay themselves a salary of up to £11,850 before any income tax becomes payable.
Next year, higher rate tax of 40% will be applicable to any income in excess of £46,350. This represents a £1,349 increase from this year. So, on top of the £11,850 tax-free allowance, a further £34,500 of salary income will be receivable in 2018/19, with income tax payable at the basic rate of 20%. This is a welcome change for many.
Despite the government’s sustained attack on pensions over the last few years, they remain a very tax efficient means of saving for retirement. Individuals with taxable earnings of up to £150,000 a year can contribute up to £40,000 to a pension each year and earn income tax relief at their marginal tax rate (note that corporate pension contributions count towards this £40,000 limit). Meanwhile, pension contributions made on behalf of the contractor by their employer company can represent a deductible expense for corporation tax along with the contractor’s salary.
As well as making the most of these allowances, contractors should also be aware of other options for their money. Contractors who are comfortable putting some money at risk might want to invest in tax-efficient investments that target higher returns than cash in the bank. There’s been a lot of innovation in recent years, and there are some great options contractors can use for their money that simply didn’t exist just a few years ago.
Innovation in ISAs
For example, Individual Savings Accounts (ISAs) have undergone something of a mini-revolution. The annual allowance for new ISA subscriptions was raised to £20,000 from April 2017 and will stay at that level in the coming tax year. The limit includes contributions of up to £4,000 into a new Lifetime ISA. UK-resident savers aged between 18 and 39 may open a new Lifetime ISA account. The government will top up savers’ contributions by 25%, providing a maximum benefit of £1,000 per tax year. The tax benefits will be retained provided the savings are used by a first-time buyer to purchase a home, or they’re left in the account until the saver reaches the age of 60.
A new type of ISA: aiming for tax efficient growth
The start of the current tax year saw the introduction of another new type of ISA. Savers can now open an Innovative Finance ISA (IFISA) alongside a cash and/or stocks and shares ISA in the same year. This ISA can act as another savings tool for contractors, enabling them to receive any interest tax-free. The £20,000 annual subscription limit includes contributions to all types of ISA including an IFISA.
IFISAs allow individuals to invest in peer-to-peer loan portfolios, as an alternative to cash or stocks and shares.
The peer-to-peer loan market has bloomed over the last few years. There’s a definite need to keep your wits about you though. For example, some IFISA providers offer to invest your money into unsecured loans. While these types of loans may target very good potential returns, naturally they come with a higher level of risk.
On the other hand, some IFISA providers, like Octopus, offer the chance for investment in portfolios of secured loans. These loans involve security being taken against a tangible asset like property which offers a way to help recover the loan capital if a borrower defaults.
Where the provider selects secured loans on behalf of the investor, the investor should look at the provider’s experience in the relevant sector. Have they got strong checks and controls to help them vet potential borrowers?
Unlike a cash ISA, these investments put your capital at risk, meaning you may not get back the full amount you invest. You should also keep in mind that instant access to your money can’t be guaranteed, and peer-to-peer investments are not covered by the Financial Services Compensation Scheme. IFISA investors take on these risks in order to seek higher target returns than they can get from a cash ISA. For example, Octopus Choice offers a target rate of 4% a year. Though this target rate is not guaranteed, it is well above the interest rates offered by cash ISAs.
Any interest earned is also tax-free, providing you invest with the IFISA wrapper. Tax treatment depends on your circumstances and may change in the future.
Venture capital trusts: complementing your salary income
Finally, another area of recent growth is Venture Capital Trusts (VCTs).
VCTs have been around since 1995. They offer tax reliefs as an incentive to invest in small early-stage companies. Investors do this by buying shares in a VCT, which in turn invests in a portfolio of young companies. In the 2016/17 tax year, £542 million was invested into VCTs1, up from £458 million the previous tax year2. VCTs may be of interest to contractors because, subject to certain criteria, contractors can get income tax relief on their investment.
For instance, any dividends paid by a VCT are tax-free. Any growth in the value of VCT shares is exempt from capital gains tax. Lastly, but perhaps of most interest to contractors, is the fact that VCT investors can benefit from 30% upfront income tax relief on the amount they invest. A contractor paying themselves with a salary or dividends from their company could reduce their income tax liability by making an investment into a VCT in the same tax year.
Now, investors also need to be mindful that VCTs are high-risk investments. The value of a VCT investment, and any income from it, can fall as well as rise, and investors may not get back the full amount they invest. Octopus does not offer investment or tax advice. Investors should seek professional advice before deciding to invest.
Also keep in mind that VCT shares could fall or rise in value more than other shares listed on the main market of the London Stock Exchange, and they may also be harder to sell.
Indeed, it’s because investors are taking on these risks that HMRC offers the incentive of tax reliefs, provided the VCT maintains its qualifying status and investors meet certain eligibility criteria, including that they hold their VCT shares for at least five years. Tax treatment depends on individual circumstances and may change in future.
VCTs also have to meet strict government rules that ensure they focus on providing capital to high-growth smaller companies in the UK. This is the reason successive governments have continued to support VCTs since they first came in more than 20 years ago. For early-stage companies they can be a vital source of capital to help them scale up. And for investors, they offer a great way to access some of the UK’s most exciting businesses while also making use of the tax reliefs VCTs offer.
For more information, email firstname.lastname@example.org or call one of the Octopus team on 0203 142 4981.
Personal opinions may change and should not be seen as advice or a recommendation. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. We record telephone calls. CAM06235. Issued: December 2017.