Restrictions on pension funding has resulted in a search for alternative tax-efficient planning; with Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EISs) being considered. Over the last 25 years the Government has encouraged investment into these higher risk schemes, which are all early stage businesses, by offering various tax reliefs as compensation for the risks.
The table below compares the tax reliefs and limits for Pensions, ISAs, VCTs and EISs.
|Income Tax Relief||Up to 45%||Nil||30%||30%|
|Capital Gains Tax||No||No||Gain Exempt||Gain Exempt after 3 years|
|IHT Free||Yes||No||No||Yes, Business relief after 2 years|
|Capital Gains Tax Deferral||No||No||No||up to 28%|
|Minimum Holding Period||Minimum pension age 55||Accessible from age 18||5 Years||3 Years|
|One Year Carry Back||No||No||No||Yes|
Greater potential for upside returns; downside underwritten.
Rather than holding all your eggs in one basket, ie. investing in a single company scheme, it is important to consider a pooled investment approach; this provides investment across a range of different companies developing different sectors. This may include technology, life sciences, and healthcare.
Whilst some companies may fail, a good EIS/VCT manager will factor this into their portfolio looking to mitigate risk and aim for overall growth.
For an additional rate taxpayer, this reduces potential exposure to loss to just 38.5 per cent of the original capital invested. The government is effectively underwriting a large chunk of the risk.
A multi-purpose planning tool
Income tax, capital gains tax, inheritance tax: few investment structures tick as many tax planning boxes as an EIS and enjoy such flexibility around the application of these reliefs:
- Income tax relief can be used in the year of investment or carried back to a prior year
- Existing capital gains can be deferred indefinitely
- Gains within the EIS portfolio are free of CGT
- Loss relief on individual failing companies can be offset against income as well as capital gains
- Once held for two years, EIS investments are free of IHT using Business Relief
All this is combined with much higher maximum investment limits over VCTs (particularly for knowledge Intensive Companies).
Impact of combined EIS reliefs Let’s take the example of a client selling a buy-to-let property with a £100,000 gain. If invested into an EIS, this gain not only results in £30,000 initial income tax relief but a deferral of the £28,000 CGT liability. This liability can be deferred indefinitely by reinvesting future proceeds back into EIS investments – gaining 30 per cent initial tax relief on each reinvestment.
On the death of the client, the CGT dies with them. Given that EIS investments are IHT-free, this investment has therefore potentially benefited from: 30 per cent initial tax relief, 28 per cent CGT and 40 per cent IHT – a combined tax benefit of 98 per cent!
Clearly the returns must justify the risk - and there is a risk that the EIS investment could fail leaving the investor with a crystallised CGT liability (albeit with loss relief available in the year of exit). But there are few instances where an advisor is able to deliver quite such a comprehensive list of benefits.
Bear in mind the risks
It is, however, important that you understand the risks before making a decision to invest. VCT and EIS investments are by their nature high risk, their share price may be volatile and they may be hard to sell. The value of this investment, can fall as well as rise, and you may not get back the full amount you invest.
Tax treatment depends on individual circumstances and may change in the future. Tax reliefs depend on these investments maintaining their qualifying status.
You will also need to be comfortable with holding the shares for at the very least three years (EIS) or five years (VCT) in order to keep any income tax relief claimed. There is often a delay in your money purchasing shares in the individual companies and then a delay in timing the best exit strategy.
In every case take independent financial and tax advice.