Tax advantages versus EIS performance

Mr Gain says the point of these is to deliver the initial investment back to investor as soon as possible after three years. The attraction of these is that the investor receives their tax reliefs and their original investment amount after three years.

This equates to a return of around 9 per cent compound a year, he points out. However, Mr Gain warns these types of schemes are likely to be closely scrutinised by HM Revenue & Customs.

Other EIS investment strategies actually look at making a larger return to investors through the growth of the underlying businesses.

Mr Gain says: “Portfolios of public houses has been popular in the past and there is evidence of both very successful and less successful portfolios. Film investment has also proved popular because of its glamorous nature but also with mixed results.

“Successful investments have been known to return hundreds of percent return while conversely they can also middle along or even fail. It is not unusual to find funds returning between 10 per cent and 60 per cent over a four to five-year period, excluding the tax relief.

“The very nature of investing in small companies is higher-risk, hence the higher tax reliefs.

“Given the supply of EIS funds investors are able to choose sectors they feel match their risk profile and in many situations will allocate capital across a number of different funds to further mitigate risk.”

Susan McDonald, executive chairman and joint founder of Calculus Capital, agrees it is really important for advisers to understand that not all EIS funds are the same.

She agrees that EIS that are primarily devices to exploit the tax reliefs, which is against the spirit of EIS and likely to be reined in – so advisers should avoid those.

Ms McDonald says: “Some providers focus on just one investment, others on a portfolio. The portfolio approach reduces risk and losses are not offset against gains. This can be a useful benefit given that any losses in underlying investments can be offset against tax.

“Changes in the rules introduced a couple of years ago allow EIS managers to invest in much bigger companies. We believe that is a good thing if you’re more risk averse.

“When building our portfolios we include a broad mix of sectors, from pharma and biotech to the Mexican restaurant chain Benito’s Hat. The common link: they are already established private companies.

“As always, you have to find the investment manager’s approach to risk that best matches your client’s. One of the best sources of information on EIS is Martin Churchill’s Tax Efficient Review, which is a subscription service.

“One tip I would suggest in choosing an EIS manager is to ask if you’d invest in the fund without the tax benefits.”