With financial advisers increasingly utilising tax-efficient investments to both assist with tax planning and to provide clients with access to growth-focused venture capital stocks, it is inevitable that the question of venture capital trusts vs the Enterprise Investment Scheme comes up.
So, what are the similarities between these long-standing government initiatives and what are the key differences?
Let us start by looking at the similarities. The key fundamentals of both EIS and VCT are:
- 30 per cent income tax relief, against income tax relating to the current tax year; and
- capital gains tax free growth, meaning no CGT being payable on exit.
That is essentially where the schemes’ similarities end.
VCT then also offers investors tax-free dividends, whereas EIS does not. However, EIS does have a number of additional facets that may be of significant interest to advisers and clients seeking some powerful tax planning.
Firstly, EIS offers investors income tax carry back relief, meaning that the 30 per cent income tax relief can be claimed against the previous tax year. This is particularly pertinent at tax-year end, after the client has submitted this previous year’s tax return on January 31 and then has a short window to get cash deployed before tax-year end to offset income tax from the previous tax year.
EIS can also be utilised to defer CGT liabilities for gains achieved within the previous three years or the upcoming 12 months.
This can be particularly powerful across a portfolio of EIS assets with CGT potentially being written off via annual allowances as the EIS portfolio achieves exits over several tax years.
EIS also offers the potential of 100 per cent inheritance tax exemption through the availability of business relief, after EIS-qualifying investment has been held for at least two years.
Further to all of these tax incentives, the EIS also offers share loss relief, which, in conjunction with income tax relief, could provide total tax relief of up to 61.5 per cent for a 45 per cent taxpayer.
As VCTs are listed funds, their shares can be subject to volatility. While this would infer that VCTs are more liquid than EIS investments, to benefit from the tax reliefs the client is required to hold VCT shares for five years. Even then, there may not be secondary trading of VCT shares so it may not always be easy to sell holdings and, of course, the value of investments can go down as well as up.
Conversely, EIS funds are products within which clients directly invest in unquoted companies. Liquidity of such assets is usually dependant on a trade sale of the company or a public listing and therefore EIS investments should be considered as being illiquid. Although you only need to hold EISs for three years to qualify for all their tax reliefs, it is unlikely that you will be able to exit immediately after the third anniversary. In reality, it could take several years before an EIS investment is realised.
VCTs tend to be more diversified than EISs as they typically invest in 30 to 70 companies. EIS investments could be held as a single investment but usually EIS funds will invest in up to a dozen companies or so, dependent on the size of the subscription.