Once a relative investment unknown, venture capital trusts (VCTs) and enterprise investment schemes (EIS) have now become a bright spot for tax-efficient investing. But their soaring popularity has resulted in a capacity crisis that could put the products at risk of becoming victims of their own success.
The context for the vehicles’ rise to prominence is continued cuts to pensions allowances. The lifetime allowance dropped from £1.8m in the 2011/12 tax year to £1m by 2016/17, while the annual allowance for high earners is also now tapering off following rule changes in April 2016.
These changes have left many savers scrambling to find tax-efficient vehicles in which to stash their savings. But as investors pile into VCTs and EIS, the products have struggled to keep up with the spike in demand.
As Table 1 shows, more than 15 VCTs alone had already closed to new business as of early March, well before the end of the tax year. That left just seven open for investment at what is traditionally the busiest time of year for the sector, as Table 2 indicates. Product providers must step back and re-examine this new tax-driven climate, especially as rule changes in 2015 made it more difficult for VCT managers to find qualifying companies.
That said, though, the products are experiencing a boost in popularity, the sustainability of inflows has yet to be determined. Investors will have their eye on future VCT and EIS launches, but also on how well these products perform under the spotlight.
Ian Sayers, chief executive of the Association of Investment Companies (AIC), does not expect investor interest in these products to abate any time soon, particularly as the VCT sector has seen the average share price rise by 82 per cent over the decade to 31 December 2016, with the added benefit of tax-free dividends and capital gains.
“From a VCT perspective, the pension rule changes and reduction in the lifetime allowance have clearly acted as a boost to investor interest, together with the established performance track record as the sector has matured.
“Clearly, there is a strong demand for income and tax-efficient investments, and frankly it is hard to see that going away any time soon,” Mr Sayers explains.
The first EIS products launched in 1993 as a way for more sophisticated investors to support small UK companies. These products received a boost in the 2012 Budget when George Osborne introduced Seed EIS, which aimed to help entrepreneurs raise funding from start-ups by giving those who invested a tax break.
VCTs got their own start in 1995, when the Conservative government at that time introduced tax breaks to encourage investors to put their money into domestic early stage companies – an area that many tend shy away from, as young companies with no business track record are often perceived as overly risky.
While getting in on a promising new company in the early stages of development can appeal to some, the main draw for VCT investors has proved to be the tax breaks they enjoy. HM Revenue & Customs has stated that shareholders who are over the age of 18 can claim income tax relief at a rate of 30 per cent on annual investments of up to £200,000, as long as the shares are held for at least five years.