OpinionDec 3 2018

Why you should consider tax-advantaged investments

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Why you should consider tax-advantaged investments

Enterprise investment schemes (EIS), venture capital trusts (VCTs) and Business Relief (BR) products are by no means new in the market place. 

BR, which was known as Business Property Relief or BPR, was first introduced in the 1976 Finance Act, EIS replaced the old Business Expansion Schemes in 1994, and VCTs were introduced in 1995. 

While figures for assets raised in BR schemes are hard to come by, 2016 to 2017 – the last tax year for which we have official figures – saw over £2.2bn raised across EIS and VCTs.

Since their inceptions, EIS and VCT have attracted over £18bn, according to figures from HM Revenue & Customs, and over £7bn into the UK SME sector, Association of Investment Companies figures show, respectively. 

However, despite all three structures having an established market with a more than 20-year track record, many financial advisers still do not include them in their tax planning arsenal – even though recent changes in government legislation and pension rules have made the investment case even more compelling.

Why does the government give tax breaks?

EIS, VCTs and BR each offer a number of distinct tax incentives allowing them to fulfil different requirements in an investor’s portfolio. For example, VCTs offer tax-free dividends, meaning they may be more suitable to an investor looking to maximise income.

However, a golden rule of investment is that you don’t get anything for free.

The tax-free dividends offered by VCTs alongside no CGT on gains make them an attractive alternative source of tax-free income, which can complement a traditional pension portfolio. 

The government’s generous tax incentives associated with these vehicles are designed to offset the risk of investing in smaller, unquoted or AIM-listed companies. Furthermore, investments must meet certain criteria both at the investor level (such as minimum holding periods to qualify) and the underlying investee company level (such as a maximum revenue size or number of staff). 

The increased risk nature of these strategies means they are not suitable for every investor – but for the right investor, they can form an important and complementary part of their overall portfolio. 

The catalysts behind the growing market

Aside from the changes in government legislation outlined above, there are a number of other factors driving the growth in the market. 

Firstly, changes in pension rules (restricting annual contributions for additional rate taxpayers and reducing lifetime contributions to £1m) have restricted the tax planning options for high earners, pushing advisers towards alternative and complimentary pension planning investments, and VCTs in particular.

The tax-free dividends offered by VCTs alongside no CGT on gains make them an attractive alternative source of tax-free income, which can complement a traditional pension portfolio. 

Secondly, the dynamics for SME asset raising through EIS and VCT structures continue to be favourable. With traditional sources of funding difficult to secure, demand for funding via EIS and VCTs far outstretches supply.

This has created a positive environment for EIS and VCT managers, with a number of potential deals in which to deploy new cash.

Finally, inheritance tax continues to be an ever-growing problem for advisers and their clients, exacerbated by rising property prices. The result is that a record number of people’s estates are due to pay IHT, and IHT receipts have doubled in the last decade.

In 2017 to 2018 over £5.2bn was collected in IHT receipts, an increase of 8 per cent on the year before. 

Even with the addition of the main residence nil rate band, the Office for Budget Responsibility forecasts inheritance tax revenues are expected to rise by nearly 11 per cent a year for the next four years, to the highest level as a share of the UK economy since the 1970s.

With the nil rate band remaining at its current level until 2020 to 2021, BR strategies offer a simple way for investors to reduce their IHT liabilities after just two years. Furthermore, BR strategies offer a flexibility, control and timescale that traditional estate planning options, such as gifting or trusts, often cannot.

There are a diverse range of EIS, VCT and BR products and managers available across multiple investment strategies and asset classes. The markets for each of these tax-efficient structures is long-established and provides billions of vital investment each year into the UK SME sector.

Each structure provides a different range of tax planning benefits, which can be tailored to the client’s investment objective. These structures can form a valuable part of an adviser’s tax planning arsenal, with demand only set to grow. 

Jack Rose is head of tax efficient products at LightTower Partners