As part of our Five Steps to Financial Freedom, advisers at Partners Wealth Management regularly speak to clients about tax efficient investing. In recent years, as the Government has made pension saving less favourable, allocating investments into Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCT) has become more topical. It is important to note that EIS and VCT investing is not a substitute for pension savings but can be used efficiently as part of your overall investment strategy.
What are VCTs?
VCTs are specialist investment companies listed on the London Stock Exchange (LSE). Newly issued VCT shares come with generous tax incentives from the Government and are designed to encourage investment in smaller UK companies.
VCT funds aim to help small businesses grow, create employment and benefit the UK economy. They tend to invest in younger companies, usually implying more risk than older, larger companies, and are selected for their rising-star potential.
Like investment trusts, VCTs are managed by professionals who aim to mitigate the risks inherent in small companies through diversification. Typically, they invest in 30 – 90 companies to reduce exposure to setbacks or failure at any one company, thus avoiding having too many eggs in one basket.
With VCT’s, the investor acquires shares in a trust, not in the individual companies, allowing exposure to the whole portfolio. This may also include larger and more mature businesses, into which the VCT invested years ago.
As VCTs are listed companies, their shares can be bought and sold on the LSE. In practice, trading in VCT shares is not particularly active, so shares tend to be valued at a discount to their Net Asset Value and may be difficult to sell. As a result, most VCTs offer a buy-back policy.
Examples of VCT backed companies include Zoopla, Cazoo, Tails.com and My 1st Years.
What are EIS investments?
EIS investments focus on the same type of companies as VCTs but invest directly in the companies resulting in less diversification. For this reason, EIS investing is riskier than VCTs and to reflect this, the tax reliefs are more generous.
One way to mitigate this risk is to access EIS opportunities through a managed portfolio. The investor would typically have access to 5 – 8 companies and be a direct shareholder of those EIS-qualifying companies.
It is possible to invest in direct EIS offers, but investors will not benefit from diversification or the insight and access to the market from experienced managers.
Generally, EIS-qualifying companies must have gross assets of less than £15 million and fewer than 250 employees. Up to £2million may be invested in an EIS, subject to £1million being invested in knowledge-intensive companies (companies carrying out research, development or innovation), who also enjoy preferential terms.
Examples of EIS backed companies include Bloom & Wild, Pasta Evangelists, Cera and Yasa.
Seed Enterprise Investment Schemes (SEIS) are focussed on start-ups and very early-stage companies. This type of investment carries more risk as investments are made into companies who are at the start of their journey. It is eligible to tax relief of 50% on investments up to £100,000.
Our approach to tax efficient investing
As part of our Tax Optimisation Strategy, we work with you to ensure that you benefit from efficiencies both now and in the future. Using these building blocks over the years can secure the first £100,000 of retirement income at a marginal rate of tax in low single figures.
Each type of investment offers a different balance of risks and rewards which could meet different clients’ requirements.
With both VCT’s and EIS, you could get up to 30% income tax relief and tax-free growth. Moreover, VCTs offer tax-free dividends whilst EIS offer potential inheritance tax and capital gains tax reliefs. Tax benefits depend on circumstances and rules can change. The allowances are also very generous: up to £200,000 a year in VCTs and up to £2m in EIS.
The table below provides an overview of how the available tax reliefs compare but you should make sure you are familiar with the considerable risk and rules before making any decision. You should invest on the merits of the investment, not for the tax advantages alone. If you are unsure, please seek professional advice.
As we classify them as high-risk products, we recommend that clients only have a maximum exposure of 25% of their investable wealth to these types of investments.
Advisers tend to recommend clients build a diversified portfolio of VCTs first. This is prudent from a risk management perspective but also makes it administratively easier compared to EIS investing, as investors will receive one share certificate and one income tax certificate shortly after the shares have been allotted in the VCT. By comparison, with EIS investing, investors will receive multiple income tax certificates, as their capital is deployed into different companies, over a 12 – 18 month period.
Please speak with your Partners Wealth Management adviser if you have an interest in learning more on this topic and the benefits and disadvantages of each type of investment.
Robert Record
Partner
rrecord@partnerswealthmanagement.co.uk
020 3148 1480
The contents of the article have been prepared solely for information purposes. The article contains information on financial products and services and such information is designed for and addressed solely to individuals seeking generic industry information. This document reflects our understanding of current legislation. Past performance is no guide to future returns.