Get free updates - subscribe to our monthly newsletter Subscribe
I have written about the tax benefits of investing in pensions and Individual Savings Accounts (ISAs). This time I will explore two tax efficient, but less well known investment vehicles - Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EIS).
These investments can be a way to add diversification to a portfolio once annual ISA and pension allowances have been used up, although they will only appeal to a relatively narrow band of investors, as they carry significantly higher risks to capital than more conventional investments.
Perhaps the most attractive aspect of investing in either a VCT or EIS is that they provide Income Tax relief at a whopping 30%. There are, however, many differences between the two arrangements and a number of factors to consider when choosing which to invest in, one of the most evident being the required holding period to qualify for tax relief - VCTs have to be held for five years, whereas EISs only have to be held for three years.
Claiming tax relief on VCTs is simpler, as the tax relief certificate usually comes with the share certificate, which is usually issued a matter of weeks after you buy the shares, whereas with some EISs, you only get the relief when the provider with which you invest places money into an underlying business and it starts trading, so the waiting period can be longer.
Changes recently announced in the Budget mean that you can now invest up to £1 million a year in EIS, but this figure is £200,000 a year for VCTs. In both instances, this annual allowance is much higher than the amount you can put into a pension on a yearly basis, and unlike pensions, neither has a lifetime limit. If you are to consider an EIS or VCT this should usually be in addition to your pension and not an alternative - these are venture capital investments and almost always substantially higher risk than the underlying investments in pensions.
EISs and VCTs can also be used for income generation. Generalists, or Alternative Investment Market (AIM) VCTs, which can pay attractive dividend streams, are perhaps the best option because the dividends are exempt from tax. EIS dividends are not tax free, so in general, if you are looking for income VCTs are the better option of the two.
EISs are generally more suited to pure tax planning, particularly for mitigation of Inheritance Tax (IHT) and/or Capital Gains Tax (CGT). An investment in an EIS can be passed on to your heirs without incurring IHT (if you have held the investment for a minimum of two years) whereas VCT shares, like most other investments, would form part of your estate for IHT purposes.
If you have incurred CGT on a profit, but invest that profit into an EIS, you can defer paying this tax bill until you realise your EIS gains. If you die before realising the EIS investment, the CGT liability will die with you – so your heirs would receive the EIS investment without it being subject to CGT. Neither of these can be done with a VCT, though any profits on both VCT and EIS investments themselves are free from CGT. If the underlying investments within an EIS make a loss you can offset this against your Income Tax in the same year, or the preceding one. You can also offset it against capital gains in the same year, or carry it forward to offset against future gains.
When it comes to tax efficient investments, there’s a useful phrase to remember - ‘don’t let the tax tail wag the investment dog’. In other words, the underlying investment should be a good opportunity in itself, not just a tax saving vehicle, but please be aware that due to the complexities and risks involved with these arrangements, it is essential to take independent financial advice and be fully aware of the risks involved before considering any investment.
Investment values can fall as well as rise and you may get back less than you invest.
Past performance is not a reliable indicator of future results.
Financial Planning Consultant
If you like this article and would like our FREE updates sent straight to your inbox then subscribe to our monthly newsletterSubscribe
All content © 2015 Armstrong Watson. All Rights Reserved. Website by Simon Pighills.
Armstrong Watson LLP is a limited liability partnership registered in England and Wales, number OC415608. The registered office is 15 Victoria Place, Carlisle, CA1 1EW where a list of members is kept. Armstrong Watson LLP is regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. Unless otherwise indicated, either expressly or by the context, we use the word “partner” to describe a member of Armstrong Watson LLP or an employee of Armstrong Watson LLP in their capacity as such.
Armstrong Watson Audit Limited is registered to carry on audit work in the UK and Ireland by the Institute of Chartered Accountants in England and Wales. Registered as a limited company in England and Wales, number 8800970. The registered office is 15 Victoria Place, Carlisle, CA1 1EW.
Armstrong Watson Financial Planning Limited is authorised and regulated by the Financial Conduct Authority. Firm reference number 542122. Registered as a limited company in England and Wales, number 7208672. The registered office is 15 Victoria Place, Carlisle, CA1 1EW. Armstrong Watson Financial Planning & Wealth Management is a trading style of Armstrong Watson Financial Planning Limited.
Armstrong Watson Trustees Limited is a limited company registered in England and Wales, number 84495656. The registered office is 15 Victoria Place, Carlisle, CA1 1EW.