Advisers are preparing to have their tax advice further curtailed as the £1.6bn a year enterprise investment scheme sector becomes the latest market put under threat by rules forecast to be in announced in the upcoming Budget.
Investing in EIS has been encouraged by successive governments to raise funds for a number of small, unlisted businesses, and this is reflected in the high rates of tax relief on offer.
People can invest up to £1m in any tax year and receive 30 per cent tax relief. Plus any gain is capital gains tax free if the shares are held for at least three years and the income tax relief was claimed on them.
According to the EIS Association, since 1994 investors have ploughed £15.9bn into EIS. Last year alone they raised £1.6bn.
However there are concerns plans are afoot at within government to restrict which businesses investors can back in exchange for the generous EIS tax breaks.
In August the Treasury published a consultation paper entitled “Financing Growth in Innovative Firms”.
With regard to the EIS market, the Treasury paper claims “the majority” of EIS funds are motivated by capital preservation, and it estimates that 40 per cent of the companies that received EIS funding could have accessed a form of credit that does not require a tax break.
If correct, this runs contrary to the reasons for the tax breaks EIS enjoy - namely that they invest in growth companies that create economic activity and employment, and which struggle to gain access to funding elsewhere because they are young and high-risk.
As a result there are fears EIS face having their tax breaks withdrawn in the upcoming November Budget, or the rules around access to EIS tightened.
Mark Brownridge, chief executive of the EIS Association said he has been “actively” engaging with the Treasury on this matter and the message he has received is that EIS investors need to focus more on “innovative companies”.
The Treasury refused to comment, but if it goes ahead the move would see further restrictions placed on advisers trying to arrange their clients' tax affairs, as an addition to anticipated changes to venture capital trusts.
As FTAdviser revealed last week, the forthcoming Autumn Budget is already set to change the rules around the sort of assets into which VCTs, as similar tax-efficient investment, can invest, prompting one provider to suspend a fundraising.
Alex Davies, who runs advisory firm Wealth Club, described the reasons to curb EIS tax breaks as “nonsense”.
He said he finds it difficult to understand how any conclusion EIS are not being used to help businesses that would otherwise struggle to find capital could have been reached.
He said: “There is no doubt as a country we want to be investing more in high growth potentially world class companies.
"However let’s not forget the more down to earth activities such as building and running pubs, wedding venues, all create lots of jobs and have a multiplier effect on the economy.
"[Restricting EIS] won’t help investment in these high growth potential areas.
"Most investors we meet who invest in EIS and VCTs want a balanced portfolio. They are more than happy to invest in some very high octane investments where the return may not be for many years, but they want to balance that out with investment areas such as asset rich and media EIS which whilst far from being risk free should be less volatile and also more tangible.”
Ben Yearsley, director at Shore Financial Planning said high-net worth clients, for whom EIS can take over when pension and Isa allowances have been exhausted, will take the hit from any tightening of the rules.
But he admitted client demand seems to focus on the lower risk end of the spectrum rather than high risk EIS.
"This seems to suggest they want the tax efficiency of EIS rather than the prospect of high growth.
"I think if you look at the industry generally, capital preservation EIS has been by far the most popular.
"Therefore any more changes to the rules would probably mean less money invested and fewer clients using them."
The EIS Association's Mr Brownridge said the problem businesses typically have with obtaining funding tends to be at a later stage in their development than the companies which attract EIS funding, so any planned restrictions would not achieve what he believes is the aim of the Treasury.
The issue is around asset-backed businesses. It is understood the Treasury want the rules for investment in asset-based businesses in EIS and VCTs to be changed.
Mr Brownridge said the EIS market has been moving “organically” towards having fewer asset backed businesses, and so questioned the need for the Treasury to act.
He said the Treasury’s definition of an asset backed business is more “nuanced” than simply a business that owns an asset.
He said the Treasury is concerned about businesses that derive a rental income from a property asset, and as part of his organisations submission to the Patient Capital Review, he has proposed that investments in freehold property and property with leases of longer than 25 years be excluded from EIS investments.
Mr Brownridge said a majority of EIS funds in 2016 were motivated by capital preservation but that the direction of travel is for those type of investments to become a smaller part of the total.
David.Thorpe@ft.com
