Venture Capital Trusts (VCT) and Enterprise Investment Schemes (EIS)

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.
 

Nathan Glaister
Financial Planning Consultant

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