Following Chancellor George Osborne’s Budget, the rules will change significantly for venture capital trusts and, more importantly, enterprise investment schemes.
Both now qualify for 30 per cent income tax relief, up from 20 per cent for EIS, on the amount invested but capped at £200,000 per person per tax year for VCTs and £1m for EIS, up from £500,000.
VCTs offer tax-free dividends and tax-free capital growth. EIS offer tax-free capital growth plus an ability to shelter a capital gain made up to 12 months previously, relief from inheritance tax after two years and tax relief against any losses in the EIS. Both funds can now invest in substantially bigger companies – up to 250 employees from 50 and £15m gross assets, previously set at £7m.
Even at this increased size, the companies remain small and therefore their survival is less likely than bigger firms.
However, for the right client, these funds should form part of a diversified and well managed portfolio.
In the first instance, advisers should ignore the attractiveness of the tax benefits available and review the investment strategy of the fund. Is it concentrated on a single company?
In my experience, such funds are in the minority. Have the managers got experience and track record in the sector and not just the VCT and EIS market? Do you under- stand the risk mitigation strategies the managers will apply?
Understanding the product will enable you to assess which clients these opportunities are most suitable for and you will be better placed to prove to the FSA that these are suitable investments for your clients.
Only then should the tax mitigation on offer form part of the analysis. This is because an investor in an EIS or VCT will not lose all their original capital in the event of failure. If we assume total failure, which in a portfolio approach is without precedent, an investor in a VCT will lose 70p for every pound invested, having received 30p tax relief.
In an EIS, the investor not only receives and keeps the 30p but will also be able to claim loss relief on the remaining 70p.
Taken against income for a highest-rate taxpayer, they will be able to claim a further 35p (50 per cent x 70p) reducing the cash loss to 35p in the pound. This sum is reduced further if a capital gain was sheltered.
Advisers should not overlook a client’s attitude to risk in favour of the tax reliefs but it should be factored in that when considering capacity for losses, these vehicles, particularly in the case of EIS, mean a reduction in overall risk profile of the fund.
Jonathan Gain is CEO of Stellar Asset Management