EIS and VCT – Use Them or Lose Them:
It will probably come as no surprise that the current tax year ends on Monday 5th April. Nonetheless, there will be the usual scrabble to finalise everything. And, no doubt, the familiar refrain ‘Make the most of your pension and ISA allowances before the cut-off’ will be on the lips of every accountant and financial adviser across the country. What you might hear slightly less often, though – and which is equally as important for many investors, is ‘make the most of EIS and VCT allowances.’
If you’re anything like me, your primary instinct will be to discard the mention of that financial jargon into the nearest ‘twaddle’ receptacle in your brain. At least, for me, I have access to five brains to whom that actually means something. So, fear not! I have asked our financial oracles to explain.
They told me (much to my disappointment, actually!), EIS and VCT are not something Old McDonald had on his/her farm. They refer, in fact, to Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCT). Reading the equally blank expression on my face, I was (once again!) relieved that they clarified before I had to ask!
So, what exactly are Venture Capital Trusts and the Enterprise Investment Scheme? How can they benefit investors? And what are their risks and rewards? Here goes!
Venture Capital Trusts
Venture Capital Trusts are companies listed on the London Stock Exchange that raise money from investors and use it to invest in younger, innovative companies. As such, the diagram above represents a neat way of thinking about them. Money is raised from ‘sophisticated’ individuals and forms the ‘startup accelerator.’ Those funds are used as a catalyst to drive the business forward – the venture investment stage. And when these (hopefully!) take off, the original investment sees an increase to the ‘investment fund.’
VCTs – Tax Benefits
One of the attractive features of VCTs is the 30% income tax relief on investments of up to £200,000 per year, which provides an incentive to support this type of investment.
Tax relief comes by way of a credit against an investor’s total tax liability, but it cannot exceed the tax owed for the relevant year. It is worth noting, though, that the relief only applies to new VCTs. Also, if the investment is not held for five years, HMRC are allowed to claw back the tax relief.
Any dividend income declared by a VCT is free from income tax too, which which can make them an attractive to those seeking additional income.
A further tax advantage comes in the form of Capital Gains Tax. Namely, there is none to pay on the sale of your VCT shares, providing that the company you invested in has VCT status. Please note that this applies even if you do not hold the shares for five years.
VCT’s – Be aware
Clearly, the significant tax advantages to Venture Capital Trusts are attractive. But the maxim about ‘not letting the tax tail wag the investment dog’ holds true. Investors need to be comfortable with the attendant risks associated with backing smaller, less well-established companies, which – by definition – carry more risk.
Furthermore any dividend income is not guaranteed and can fluctuate.
It can also be hard to find buyers when you want to sell your VCT – there isn’t always a ready, secondary market for VCT’s. VCTs also tend to come with higher fees and also the possibility of ‘performance’ fee and an investor must accept that some, or all, of the original capital, could be lost.
Enterprise Investment Scheme
The Enterprise Investment Scheme (EIS) is similar in some respect to VCTs, in that investment can help business start-ups and early-stage companies get off the ground. EIS shares will usually involve smaller, non-listed companies . Typically, they have gross assets of less than £15 million at the time of investment and less than 250 employees. As with VCTs, EIS comes with generous tax relief potential.
EIS – Tax Benefits
As with VCT’s, investors enjoy 30% income tax relief. But! (there’s always a but!) – the amounts are much larger than with VCTs. With EIS shares, investors can get relief on up to £1m invested per tax year, or £2m providing that £1m of that goes into ‘knowledge intensive’ companies. The income tax relief can be clawed back by HMRC if the investment is not held for a minimum of 3 years.
As with VCT, Capital Gains Tax is not payable on the sale of EIS shares, providing all qualification criteria have been met.
Furthermore, once EIS shares have been held for two years they can qualify for Business Property Relief, which can have potential inheritance tax benefits.
EIS – The Disadvantages
Similar to VCTs, EIS shares also come with their fair share of risk. Investors must square themselves with the fact that they will invest their money in companies unlikely to have a proven track record. So, their investment is high risk.
That said, losses on the sale of EIS shares can often be offset against an investor’s income tax or CGT liability. So, for many worried about the element of risk, there is something of a ‘sweetener.’
The tax relief that comes with both VCTs and the EIS will be attractive to some investors. Both schemes are high risk though, so investors need to weigh this up against any potential rewards.