How government policy affects VCT and EIS

According to George Bull, senior tax partner for RSM UK, “Over the years, there have been many changes to the statute and regulations which give effect to both EIS and VCTs.

“Many people have found it difficult to come to terms with the frequent changes, which result in a loss of certainty.

“Moreover, even HM Revenue & Customs finds it difficult to keep up. For example, on 10 May 2016 HMRC published its guidance on the changes announced in the Finance Act 2015.

“That kind of delay certainly does not help potential investors find their way through complex and uncertain legislation.”

In the 2016 Budget, there was a significant tax boost to enterprise investment schemes (EIS) hidden in the details.

Although chancellor George Osborne did not specifically mention measures designed to boost these schemes, as he had in previous Budgets, he unveiled deep cuts to capital gains tax.

The CGT rate fell from from 28 per cent to 20 per cent at the higher end, and from 18 per cent to 10 per cent for basic rate taxpayers. This came into effect in April this year.

At the time, Jason Hollands, managing director of business and communications for Tilney Bestinvest, said these cuts “look set to prompt a stampede of interest in EIS.”

Investors need to fully understand the nature of the investments and the risks involved, as do their advisers John Glencross

He explains: “This is because investment in EIS not only provides a 30 per cent income tax credit, it also enables those who have incurred a capital gain to defer their capital gains tax liability by reinvesting their gain into EIS companies.”

Although the tax liability doesn’t disappear, but recrystallises when the shares are sold, it would then be calculated at the prevailing CGT rates at that time, so Mr Holland says the cuts will prove beneficial.

Mr Hollands explains: “This deferral feature can apply to gains incurred up to 36-months before subscribing for the EIS shares.

“This means those who have realised a hefty gain over the past three years - for example on the sale of shares - now have an additional incentive to make use of EIS to defer that gain and reduce their tax liability when the gain recrystallises at the new, lower rates.”

But what has the chancellor taken away? The ability to invest through these into renewable energy projects.

Previously promoted heavily by the government as a means to get more people to invest in eco-friendly, tax-efficient savings vehicles, Mr Osborne announced that, as of 6 April this year, energy generation was no longer be included in EIS and VCT investments.

Yet, according to John Glencross, chief executive of Calculus Capital, these changes do not necessarily make EIS or VCTs any more or less attractive “but they do mean investors need to fully understand the nature of the investments and the risks involved, as do their advisers”.

Other tax changes

Such schemes have undergone several changes at the hands of government in recent years. Big changes to VCTs since 2006 are listed in the government document VCTs: Introduction to National and Official Statistics.

Amendments to EIS and VCT schemes are outlined in full in HM Revenue & Customs’ internal Venture Capital Schemes Manual: Changes to the Enterprise Investment Scheme and Venture Capital Trusts rules introduced by Finance Act (No.2) 2015.

Both show many changes to EIS, VCTs and SEIS have happened since the coalition government was created in 2010.

In his March Budget 2011, chancellor George Osborne announced a series of measures specifically designed to boost EIS and VCT investment.

These included the increase of income tax relief from 20 per cent to 30 per cent and the fact that, from April 2012, VCTs and EISs were able to invest in a broader spectrum of companies.

This included companies with up to 250 employees (up from a limit of 100) and businesses with gross assets up from £7m to £15m.

The annual investment limit for qualifying companies was also increased in both vehicles from £5m to £10m, and the annual investment limit for individuals to £1m.

Recent rule changes have narrowed the range of available investments but a host of opportunities across a broad spectrum of risk is still available Hugi Clarke

In 2013, Mr Osborne announced a limited extension on the 50 per cent income tax relief under the Seed EIS scheme for investments made into small, early-stage companies.

Originally it was only available for the 2012 to 2013 tax year but was extended to 2013 to 2014 - at half the rate.

According to RSM UK’s George Bull, “the general view of the SEIS is it’s both welcome and has the potential to be highly effective, although the legislation is complex and now the limit on relief is relatively low.”

Tightening criteria

While tax changes have been few and far between in recent years - it is the “tightening” of the investment criteria which has caught the eye of Tilney Bestinvest’s Mr Hollands.

He explains: “The main changes were the introduction of a new age rule under the schemes, which means a business must be no more than seven years old from its first commercial sale. Previously, there were no such restrictions.

“Secondly, a significant restriction is VCT and EIS money cannot be used to buyout an existing shareholder and must be used as growth or development capital.

“This prevents what has historically been a very popular deal type for many generalist VCTs, namely management buy-outs, which are broadly lower-risk in nature. Instead, VCTs are being recalibrated towards genuine venture development capital activity.

“A third change has been the introduction of an overall lifetime cap a business can receive across the various government-aided schemes to £12m (£20m for knowledge-intensive companies), where none previously existed.”

Taken together, Mr Hollands says, these changes mean a more restrictive investment universe for future deals.

“While this clearly has an immediate impact on any new EIS investments, the effect on VCTs will be more evolutionary in nature, since most VCT fund-raising activity is undertaken each year by existing portfolios.”

Generally positive

Most respondents to this guide believe government intervention over recent years has been positive for EIS and VCT investment.

Mr Glencross explains: “It has refined and refocused the funding rules for EIS and VCTs to ensure support and reliefs are available for those companies which would not normally have been able to access growth capital.

“Recent changes have placed more emphasis on smaller and younger companies, arguably making the return potential from EIS and VCTs greater, provided you do your research and due diligence thoroughly and invest in a diversified portfolio of carefully selected, good-quality businesses.”

Even given the restrictions outlined by Mr Hollands, Hugi Clarke, director at the Foresight Group, says: “VCT and EIS have proven to be important and valuable ways of stimulating small business, emerging technologies and supporting infrastructure, and therefore continue to be supported by the UK government.

“Recent rule changes have narrowed the range of available investments but a host of opportunities across a broad spectrum of risk is still available.

“This is aligned to generous tax benefits, which continue to make EIS and VCTs attractive investment options for appropriate investors.”