Whenever there is a Budget or an election for that matter I approach the moment with trepidation. What will the government do next to my savings? What perfectly legitimate way of investing will suddenly be called a loophole and closed? What new rule will be introduced in the name of fairness?
Anyone considered “reasonably wealthy” who has bothered to save and accumulate a sensible level of assets is likely to have similar thoughts. They will already have suffered from the crackdown on buy-to-let investing, pensions and the dividend tax. They will also know the onslaught is likely to continue, with little option but to vote for the party that squeezes them least financially, rather than benefits them the most.
It is therefore hardly surprising that tax-efficient investments – Venture Capital Trusts (VCTs) and Enterprise and Seed Enterprise Investment schemes (EIS and SEIS) – are becoming increasingly popular alongside the usual pension and Isa tax shelters. Indeed this year saw nearly £550m invested in VCTs, the highest in more than a decade.
While demand is increasing, supply is not able to keep the same pace of rapid growth. Popular VCTs were selling out in record time this year. The three Northern VCTs for instance met their combined £12.9m target in just 48 hours. Meanwhile, the Foresight VCT filled its £20m over allotment facility in just 12 days. At the same time, the type of EIS deals – asset-backed ones – which most people really want, were much harder to come by.
The gulf between high demand and weak supply has created a well-documented supply gap. The reason for this gap can be blamed on a number of changes which have restricted where VCTs and EIS can invest. These changes have left many providers scrabbling around trying to decipher the rules, re-assessing their strategy rather than going out and being able to really make the most of the opportunity.
This does not mean that investors cannot find good opportunities. The good news is that there are still good deals out there and arguably VCTs, EIS and SEIS money is now being directed where it should be, that is, to companies that really need the support.
However, these changes have also meant that these schemes already perceived as high risk have now got riskier. But how risky are they really? There is no doubt VCTs, EIS and SEIS are more risky than a more mainstream investment. Small companies fail more frequently than large ones and the new rules mean you are likely to be investing in even smaller companies. Without a doubt if you cannot afford to lose the money you should not invest. But in my opinion they are not nearly as risky as many people think – even with the rule changes.
If we look at VCTs first, typically your money will be spread over 30 to 60 companies – that is quite a diversified portfolio – and do not forget you have a 30 per cent cushion in the form of tax relief when you invest. These companies represent our future. They are agile. Not big supertankers where every minor decision takes 50 people in a meeting room.
EIS and SEIS are more risky still, and can be illiquid because they are not listed on any stock market. However to compensate for this, and to incentivise investment, the government offers even better tax breaks. The maximum a 45 per cent taxpayer could effectively lose on a £10,000 SEIS investment is as little as £1,750 if they are using all the tax reliefs available. Furthermore even if the investment performs poorly the effective return as result of the tax relief can be impressive.
Investing through EIS and SEIS in particular can be more tangible than mainstream investments. You can invest in a new pub for instance. You can see it, touch it and have a drink there. If things do not go according to plan, there is likely to still be some value in the pub building itself: this asset-backing can also serve to reduce the risk.
As the saying goes, you should never let the tax tail wag the dog. However at the same time, you should not ignore it. Someone with a £30,000 income tax bill and a £28,000 CGT bill could simply pay the bill and be £58,000 worse off immediately. Or they could invest £100,000 in an EIS and have that £58,000 working for them. Arguably doing nothing is a risk in itself.
But surely if the tax breaks are so good, is there a risk these will get squeezed further? There are no guarantees and certainly since the financial crisis policies seem to disproportionately adversely impact wealthier individuals. Personally however I think the government is unlikely to damage these tax breaks significantly. Business is vital for post-Brexit Britain. Small companies create thousands of jobs and taxpayers.
Indeed a recent report by Octopus highlighted 22,470 high growth smaller businesses. These companies created on average 4,500 new jobs a week in 2014, that’s three times the number of jobs created by the entire FTSE 100. Perhaps if we are lucky they will even reverse some of the changes which have affected capacity.
For this reason I see VCTs, EIS and SEIS becoming an increasingly mainstream choice for investors with a slightly higher risk appetite.
Alex Davies is chief executive of Wealth Club
Key points
Tax-efficient investments are becoming increasingly popular alongside other tax shelters.
VCTs typically spread one's money over 30 to 60 companies.
If the tax breaks are so good, there is a risk these will get squeezed.
