Long ReadDec 13 2022

Could tax rises for investors push EIS and VCT into the mainstream?

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Could tax rises for investors push EIS and VCT into the mainstream?
Credit: Simon Dawson/Bloomberg

While the government has said the Autumn Statement reduces the generosity of the tax-free allowances, it has also said it remains “supportive” of the enterprise investment scheme and venture capital trusts.

By reiterating support for the EIS, as well as for the seed EIS, the chancellor encourages private investment into early-stage ventures by offering a route for tax mitigation, says Ivan Teare, head of specialist tax portfolio services at Rathbones.

“With financial advisers’ guidance, tax-advantaged investing for patient investors can be an extremely effective use of capital,” he adds.

So as traditional investing becomes less appealing from a tax perspective, could it push more investors towards tax-efficient investments?

Mike Hodges, a partner at accountancy firm Saffery Champness, predicts that next year is likely to see more demand than usual for VCT, SEIS and EIS investments, as people plan for the capital gains tax exemption being halved.

“With the threshold halving again from April 2024, coupled with the fall in the dividend allowance to £1,000 in April next year and £500 a year later, it would be no surprise to see an increased appetite for tax-efficient investments.”

Alex Davies, CEO of Wealth Club, a non-advisory broker of tax-efficient investments, agrees that more people will turn to VCTs. He cites dividend and CGT rises, a reduction in the additional rate income tax band as well as freezes to pension allowances.

Tax-efficient investments are arguably less risky when taxes rise as reliefs become more valuable, says Davies, although, he adds, people should not rush into tax-efficient investing. “VCTs are for people who know what they’re doing and understand the risks.

“It’s for the money which you can afford to put aside to lose if necessary. This isn’t money you can access easily, and because they’re early stage businesses, you could lose the lot.”

Indeed, EIS and VCT investment opportunities are carefully targeted at investors where higher risk investments are appropriate, and who understand the opportunity and the risks, says Jess Franks, head of retail investment products at Octopus Investments. “These are long term investments, therefore it is not possible to dip in and out in order to simply access relief on investment.”

Tax relief for investors using venture capital schemes:

 EISSEISVCT
INCOME TAX RELIEF
Maximum annual investment you can claim relief on

£1mn

£2mn if at least £1mn of that is invested in knowledge-intensive companies

£100,000£200,000
Percentage of investment on which you can claim30%50%30%
Tax relief on income from dividendsNoNoYes
CGT RELIEF
Personal CGT relief available on your initial investmentYes on 100% of investmentYes on 50% of investment, capped at £50,000N/A
Type of CGT relief on initial investmentDeferralExempt from taxN/A
Gains exempt from CGT when you sell sharesYes if you received income tax reliefYes if you received income tax reliefYes
Relief available for capital losses against incomeYesYesNo
Source: GOV.UK

Although pension contributions will still be the main way to reduce income tax liability, EIS and VCT will be extra options to consider when it comes to a tax-efficient investment strategy for the highest earners, especially if they are affected by the tapered annual allowance, says Jason Hollands​, managing director, corporate affairs at Evelyn Partners.

Investors can claim up to 30 per cent income tax relief on EIS and VCT investments, but when it comes to financial planning, Hollands says the schemes have different uses.

“We see EIS as more relevant as part of an overall inheritance tax mitigation strategy, since EIS shares attract business relief after two years, and EIS can also be used to defer a capital gains tax liability.

“Investors whose primary tax goal is to reduce an income tax liability should probably prioritise VCT over EIS given the relative risks involved,” he adds.

EIS vs VCT: Who wins?

While taxes for individuals are generally going to be moving up, investors should not confuse increased appeal with decreased risk, says Andrew Martin Smith, director at Guinness Ventures, which invests in EIS-qualifying companies.

“With proper advice, investors shouldn’t conflate the challenges of higher taxation with perceived risk reduction of tax advantaged schemes,” he adds.

Indeed, EIS investing should always be considered to be high risk, says Andrew Aldridge, partner at Deepbridge Capital, an EIS provider. But within a well-diversified portfolio, he says it can add significant growth opportunities and tax advantages without affecting overall portfolio risk.

  Photo by TOLGA AKMEN/EPA-EFE/Shutterstock

It is important to recognise that the tax features of these schemes are there for a reason, reminds Hollands at Evelyn Partners.

He says: “Investing in illiquid, small, early-stage companies is high risk in nature; and that’s why VCT and EIS investing will only ever be suitable for a relatively small cohort of the wider population.

“While the tax environment will underpin interest in the schemes, do bear in mind that these types of business could struggle in a long recession too; and a chunk of funds raised will be used to feed cash-hungry companies within existing portfolios, not just finance new deals.”

As Francesca Rayneau, director at Calculus Capital, puts it, the EIS and VCT tax incentives provided by HM Revenue & Customs are extremely attractive; but investors should use the schemes based on their investment merits and their potential for generating impressive returns.

“It should not be the tax tail wagging the investment dog,” she says. “So long as the risks are fully understood, they should be considered by investors looking for long-term investments, which also maximise tax efficiency.”

Chloe Cheung is a senior features writer at FTAdviser