InvestmentsMar 5 2020

How can clients use EISs and VCTs?

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How can clients use EISs and VCTs?

But some of the tax advantages and changes to pensions could make them a more appealing prospect.

Before dipping a toe into the world of EIS and VCTs, advisers will need to have an understanding of the reliefs available and what these vehicles can hold so they are better able to make use of these for the right clients.

Risks and reliefs

These tax-efficient vehicles typically invest in smaller companies that are not listed on any stock exchange, so the investments held within them are considered higher risk.

The risk of failure is high, and partly because investments tend to be illiquid.--Andrew Robins

But to offset this, the government offers generous tax reliefs for anyone who invests via these schemes.

Annabel Brodie-Smith, communications director at the Association of Investment Companies (AIC), explains: “VCTs offer a way to invest tax-efficiently and provide funding to the UK’s most dynamic young companies. 

“A client can invest up to £200,000 in new VCT shares each year and receive 30 per cent upfront income tax relief providing the shares are held for five years. All VCT shares also benefit from tax-free dividends and capital gains.”

Under EIS, the maximum annual investment clients can claim relief on is £1m – or £2m if at least £1m of that is invested in knowledge-intensive companies, as the government stipulates.

Like VCTs, investors can claim 30 per cent upfront income tax relief, rising to 50 per cent for a Seed Enterprise Investment Scheme.

Advisers and their clients should also be aware that EIS shares must be held for at least three years and VCT funds for five years.

Andrew Robins, partner at RSM, explains why EIS and VCT vehicles are inherently high risk. 

Backing small, young companies is high-risk so it’s important advisers are aware of the risks before recommending them to clients.--Annabel Brodie-Smith

“This is partly because most EIS/VCT companies are at an early stage in their life, so the risk of failure is high, and partly because investments tend to be illiquid, requiring investors to lock funds in for at least three or five years,” he says. 

“However, the tax advantages of EIS and VCT investments recognise these risks, and for the right investor can make them a very attractive proposition.”

Long history

While the companies held within these tax-efficient vehicles are young, the structures themselves are not. 

As Ms Brodie-Smith points out, VCTs celebrate their 25th anniversary this year, adding that many managers now have established track records.

“Understandably, backing small, young companies is high-risk so it’s important advisers are aware of the risks before recommending them to clients,” she says.

While Huw Williams, partner at OC Chartered Accountants, says EIS and SEIS have been part of an investor’s armoury for years. 

“As an ad hoc investment for those looking to finance innovative (high risk, high return) businesses this is a useful protection tool from losing it all,” he says, “but any serious slice of your investments in these need to be planned. 

“These are early-stage businesses, they are risky and the key thing to remember is that you can do little to influence exit.”

Advisers should certainly be able to make use of these tax-efficient products, even if they are not likely to be the right vehicle for the majority of clients.

So who is the right investor?

Mr Robins says: “EIS and VCTs are best used by individuals with significant tax liabilities who can afford to shrug off losses if an investment goes bad.”

He notes that an EIS investment is more flexible, and provides a wider range of tax benefits, while VCTs can be better at spreading the risk of investments more widely, “which in theory should help maximise investment returns”.

Pension planning

The changing pension landscape has seen VCTs come into their own, as Ms Brodie-Smith notes.

“VCTs have become an increasingly important option for tax-efficient investing following the changes to annual pension allowances, which limited the amount higher earners can put into their pension,” she explains.

“Typically, VCTs are most suitable for investors who have reached the limit for their annual pension allowance and have an income tax liability.” 

The tax-free dividends available to investors in VCTs could also be useful for those clients who want to supplement their income in retirement, she adds.

I have plenty of clients who have made a lot of tax-free money in EIS companies, but many more whose shares became worthless.--Andrew Robins

Mr Williams believes VCTs and EIS can form part of a wider investment strategy, but that clients will need to seek financial advice and consider carefully how much they are tying up in these types of investments.

For many, the appeal may simply lie in the fact they are helping smaller, more entrepreneurial UK businesses and giving them a chance to grow and establish.

Questions to pose

Mr Robins suggests there are some questions clients should ask themselves before investing:

  • How will I feel if I lose everything? 
  • Am I happy to tie up my money for a long period? 
  • Can I use the tax reliefs available? 
  • Have I maximised less risky investments? 

According to Mr Robins, it generally makes sense to maximise pension and Isa contributions before looking at EIS and VCTs.

He adds that clients should also ask themselves what they want from their investment before making use of these vehicles.

“I have plenty of clients who have made a lot of tax-free money in EIS companies, but many more whose shares became worthless,” he says. “VCTs can still lose everything and are less likely to make you a millionaire, but returns have historically been more consistent. 

“So, boom-or-bust, or risky-but-rewarding?”

Eleanor Duncan is a freelance journalist