Mixed reaction to EIS and VCT changes

For example, enterprise investment schemes (EIS) and venture capital trusts (VCTs) did feature heavily in the Budget, as expected.

This was in part because the outcome of the government’s Patient Capital Review, launched in November 2016, was due the same day.

Richard Carter, head of fixed interest research at Quilter Cheviot, goes as far as to say “there was precious little in the Budget for investors and markets have mostly responded with a collective shrug”.

But James Gladstone, head of wealth planning at Cazenove Capital, insists the details within the full Budget documents reveal some significant changes for investors.

Devil in the detail

There were expectations Philip Hammond would announce some changes to the EIS landscape and, in this sense, he did deliver as he announced a series of changes that push back against the use of EIS and VCTs for capital preservation.

One of the chancellor's headline announcements was a doubling of the EIS annual investment allowance that qualifies for tax relief from £1m to £2m annually.

There will be a crackdown on these tax-aided schemes being used for lower risk capital preservation deals and a doubling of the amount that can be invested into enterprise investment schemes.Jason Hollands

There is a caveat though, with any amount invested over the £1m limit having to be invested in what Mr Hammond referred to as “knowledge intensive” companies.

HMRC defines these companies as those whose costs of research and development or innovation are at least 15 per cent of the company’s operating costs in at least one of the previous three years, or at least 10 per cent of the company’s operating costs in each of the previous three years.

Other stipulations include they must also have employees with a relevant Masters or higher degree who are engaged in research and development or innovation, and who comprise at least 20 per cent of the company’s total workforce.

Jason Hollands, managing director at Tilney Group, acknowledges that pre-Budget concerns about cuts to EIS and VCT tax income reliefs proved unfounded.

He points out these fears had led to a lot of early fundraising this tax year in the build up to the Budget, with around £420m already raised by VCTs alone.

One of the main announcements Mr Hammond made about VCTs was the introduction of a principles-based test, which "will ensure the schemes are focused towards investment in companies seeking investment for their long-term growth and development". 

“There will be a crackdown on these tax-aided schemes being used for lower risk capital preservation deals and a doubling of the amount that can be invested into Enterprise Investment Schemes, but only where these meet the strict criteria of being categorised as knowledge intensive companies,” Mr Hollands says.

“The devil is always in the detail and in respect of VCTs, proposals announced alongside the Budget aim to tackle VCTs adopting lower risk capital preservation strategies rather than ploughing cash into genuine, growth companies to help them expand.” 

Mr Hollands goes on: “From Royal Assent of the Finance Act, VCTs will not be able to make secured loans to companies and any returns on loan capital above 10 per cent must represent no more than a commercial return on the amount invested. 

“Alongside this, another significant measure will require VCTs to invest cash raised more quickly than under the current rules, with 30 per cent of any funds raised in an accounting period from 6 April 2018 needing to be invested in qualifying companies within 12-months after the end of the accounting period.” 

The Patient Capital Review document sets out that with effect on or after 6 April 2019 the percentage of funds VCTs must hold in qualifying holdings will increase to 80 per cent from 70 per cent, while the period VCTs have to reinvest gains will double from six to 12 months.

Mr Hollands warns this could increase the risk profile of some VCTs.

Jack Rose, head of tax-efficient investment at LGBR Capital agrees these changes will "slightly migrate the risk profile of VCTs".

But he also concedes: "I don’t think any of these changes are particularly onerous. I think they’re fair and balanced."

It was all part of Mr Hammond's "action plan to unlock over £20bn of new investment in UK scale-up businesses", including through a new fund in the British Business Bank, seeded with £2.5bn of public money, which the chancellor announced in his speech.

Warm welcome

Those in the EIS and VCT industry largely welcomed Mr Hammond’s proposals.

Dr Ilian Iliev, chief executive of EcoMachines Ventures, notes: “Last year there was approximately £2bn invested in EIS funds. More than half of that was around various types of capital preservation/lower risk/asset-preservation schemes. 

“So, there's potentially a very large pot of investible money that may be looking for a new home.”

With all the changes to pensions beginning to bite, this type of investment is only going to grow in popularity.Alex Davies

David Mott, managing partner at Oxford Capital, hails the chancellor’s Budget as one for “ambitious entrepreneurs”.

“Focusing EIS tax reliefs on tech-focused investments will help to launch thousands of new UK businesses, creating high-value jobs and investing in the R&D that will make the UK a force in the global markets for the years to come,” he insists.

“Tech companies can now raise up to £10m a year from EIS and VCT investors, double the current rate. We are all excited about building bigger and stronger businesses.”

There has been increasing demand for EIS and VCTs following the changes to pensions.

Alex Davies, chief executive of Wealth Club, suggests it has been a good Budget for EIS and VCT investors.

“It rewards entrepreneurial companies and investors who are prepared to take some risk to support British business. While there will be restrictions on some capital preservation-focused products, investments made in the spirit of EIS will benefit burgeoning business and their investors,” he confirms.

“With all the changes to pensions beginning to bite, this type of investment is only going to grow in popularity.”

Any real impact?

But not everyone was quite as enthusiastic.

Svenja Keller, head of wealth planning at Killik & Co, questions how much of an impact doubling the allowance for EIS tax relief will have for the majority of investors. 

“For example, an investor would require an income tax bill of £600,000 in order to receive 30 per cent income tax relief on a £2m investment,” she explains. “This seems excessive when the £1m allowance was already quite generous.

"This increased allowance is also only for ‘knowledge intensive’ firms, whereas all other EIS investments seem to remain at the £1m allowance.

"In terms of capital preservation EIS, they have not reduced the allowance but are introducing a test to ‘prevent low risk capital preservation investments qualifying for the reliefs’. This should reduce, if not eliminate, the availability of lower risk EISs within the market."

Phil Cook, private client partner at Thomas Miller Investment, points out: "The reliefs on income tax, capital gains tax and inheritance tax remain in place and this is an important offset to the high risk nature of EIS, where loss of capital is a realistic outcome.

"Clearly the Treasury wishes to focus investment in specific areas and in high risk/high growth sectors, which is in line with the spirit of the legislation, but it is important investors are rewarded for the risks that they are willing to take in supporting smaller high-risk companies."

He too has his doubts about the increased allowance. He says: "Whether doubling of the EIS allowance for knowledge intensive companies will help raise further capital is questionable as most investments in EIS are relatively small and individuals, with deeper pockets, may already invest £2m using carry back to a previous tax year.

"Only time will tell if this measure actually leads to further investment.”

Muted market

The stockmarket reaction to Mr Hammond’s Budget was muted, to say the least.

Russ Mould, investment director at AJ Bell, observes: “When Mr Hammond stood up the FTSE 100 was trading at 7,448. An hour later, when he had finished, it was almost exactly unchanged.” 

The pound largely shrugged off the downgrade to GDP growth forecasts, coming in largely unchanged against the euro.Russ Mould

It was a similar story for bonds, with the yield on the benchmark UK 10-year government bond, or gilt, trading between 1.28 per cent and 1.29 per cent, according to Mr Mould, “as bond vigilantes welcomed the chancellor’s ongoing determination to reduce the annual deficit and rein in the aggregate deficit, at least on a percentage of GDP basis”.

“The pound largely shrugged off the downgrade to GDP growth forecasts, coming in largely unchanged against the euro just below €1.13 and actually rising against the dollar (after an initial tumble) toward $1.3275,” he adds.

Roadmap for the industry

Buried on page 50 of the Budget document was an announcement about a new strategy for the asset management industry.

It states: “The government will publish a new long term strategy to ensure that the UK asset management industry continues to thrive and deliver the best possible outcomes for investors and the UK economy.

"This will include actions, to be taken forward in close collaboration with the industry, on skills, harnessing financial technology solutions, mainstreaming innovative investment strategies, and continuing a coordinated programme of international engagement.”

There was not much more detail on this for now, but the industry trade body did acknowledge it in a statement.

The Investment Association’s chief executive, Chris Cummings, says: “This strategy forms part of a package of measures, alongside the Asset Management Taskforce launched this autumn, which will provide our sector with a roadmap to help firms thrive through Brexit and beyond. 

“These measures will help to ensure our industry continues to deliver the best possible outcomes for savers and the UK economy in the years to come.”

eleanor.duncan@ft.com