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Phil Young: A word of warning on VCTs and EISs

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As we approach tax year-end and with pension tax allowances continuing to shrink, I have noticed an increased interest in alternative income tax relief investments such as enterprise investment schemes/seed enterprise investment schemes and venture capital trusts.

But while these products can be the right recommendation, they should not be seen as the next-in-line investment for anyone who has maximised their Isa and pension allowances. Here is a reminder of some of the reasons why.

Risk

EISs and VCTs are high risk. And they are supposed to be. The generous income tax relief is designed to encourage wealthy people to inject money they can afford to lose into young and risky businesses.

We have already seen tax relief eligibility removed from industries such as renewables, where investment is deemed not to be risky enough to deserve the relief. So it is safe to assume all these investments are particularly risky.

While the underlying investment needs to be considered, it is not part of a standard approach to long-term portfolio construction and, especially if you are passive, will not necessarily fit in with your investment philosophy.

Specific risks include:

  • Illiquidity: long-term investment in small, unlisted companies with limited or no opportunity to trade. Providers might provide a buyback option but this is on their terms. Investors often have no other option when it comes to exiting
  • Legislation: there is no guarantee the investments will remain eligible for the reliefs
  • Performance: the tax relief could well be the only return the investor sees
  • Concentration risk: investment is in niche sectors, leaving this part of the client’s portfolio exposed to the risks of a single market
  • Compensation: investors are not usually eligible for compensation
  • Fees: charges are often higher than other mainstream investments and will eat into the already uncertain returns.

Appropriate knowledge and experience

Continuing professional develop-ment records should demonstrate you have the appropriate level of knowledge to advise on these investments.  Depending on the structure of the investment, you may need an additional securities qualification, such as CII J10, along with an amended Statement of Professional Standing.

Some training and competence schemes require an adviser to be “licensed” by the firm to advise on such products or for such advice to be pre-approved before presenting to a client. Pre-approval as a minimum is the norm.

Financial promotion

You need to be very careful if promoting a VCT or EIS, as it needs to be aimed at the right audience and highlight all the relevant risks.  This means you will probably only promote it to clients who already have these investments, if at all. Some providers also restrict the sale of their investments by asking applicants to self-certify as a high-net-worth/sophisticated investor.

Which one?

I often see a fair bit of “localism” in VCT selection, where a lot of business goes to the same provider and a relationship is struck up. This implies a fair analysis of the whole of the market is not always taking place in every recommendation. There are good reasons why you might be consistently using the same providers but you need to be able to evidence this for each case.

A number of firms review the likes of VCTs and EISs within their investment committee and create a panel using research from suppliers such as Martin Churchill, Allenbridge and Micap. Certainly, using specialists to pin down the right solutions can be far more efficient than leaving it to individual research from scratch. Telling an adviser to research from the whole of the market without offering any guidance or tools often leads to confusion.

No suitability short-cuts

There is no avoiding the full disclosure and suitability require-ments for these investments, even if the investor is in a rush to get money in before the tax year-end. A complete assessment, including a full report and demonstration of suitability on the client file, is needed. You need to demonstrate the client has the relevant knowledge and experience to be investing in these products, and why they are doing so now.

It should be clear why the amount selected to invest is appropriate and what the specific objectives are.

Given the unusual nature of the investment and the fact it is unlikely to fit in with your usual portfolio management, it makes sense not to report on it as just another part of your client’s long-term investment portfolio, and deal with it separately.

Professional indemnity

Check your PI cover allows for advising on these investments and the implication on future premiums. Insurers have pulled cover on VCTs in years gone by.

None of this is new but as tax and legislation changes around us, it is useful to remember the risks inherent in more unusual investments remains the same.

Phil Young is managing director at Threesixty

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Comments

There are 16 comments at the moment, we would love to hear your opinion too.

  1. Good piece. Particularly specific risks.

    Although I admit that this may not apply to every one of them I always took the mnemonics to stand for:

    Void Capital Totally and Every Investment Sinks.

    Talk about the ‘tax tail wagging the investment dog’!

    • Dear Old Harry. Thought you had disappeared! Perish the thought! If you choose carefully, as you suggest, in VCT you can be 100% asset backed in the 1995 original Albion Ventures VCT plc (88% property and 12% cash) which operates under the 1995 rules. This enables me to write letters to the trade and national press under the headline “How to earn over 6% per annum TAX FREE and sleep soundly at night at age 83.”

      EIS is a different matter although I did manage to get all my money back from an Edge pop music issue in my one foray in to the sector. I even completed a fifteen year Film Partnershp successfully. As in all these tax shelters, you’ve got to know what you are doing and caveat emptor applies.

      Cheerio and regards, old timer!

      David Sherman ACSI Cert PFS

  2. Excellent article. I was always taught that a tax incentive shouldn’t be the only thing pertinent to the investment. Too often you see someone suggest an EIS when pensions are used up for example, with no heed to the suitability of the higher risk nature of the investment or a simply one liner such as “this is higher than your usual ATR but you are willing to accept this for the tax break involved”.

  3. Yes Phil
    You are absolutely correct, but equally advisers need to know what this sector is about, and there are some very good providers out there. One of the best I’ve used is Comiited Capital, they have a great team running real EIS. Not based on some spurious almost cast iron concession which disappears. A bit like pension tax relief!! A risky long term strategy only because the government have dunk their fangs into the rich seam of pension funds.
    Whilst ther are risks with EIS and VCT, equally there are huge risks of not advising on them where the circumstances are correct. However trying to stay ahead of the next review by those idiots at the FCA is impossible, what’s good today is bad tomorrow.

  4. I thought all forms of investing carried a degree of risk? And, equally, NOT investing also carries with it a form of risk.

    If the human race didn’t take risks we’d all still be living in caves.

  5. For those who think you should make a decision based purely on tax benefits and ignore risk, I remind you that two of the best tax planning tools available are getting married and dying.

  6. I like the line “this means you will probably only promote it to clients who already have this investments”…a bit like “only experienced applicants need apply for this job”! If non-one invests in a VCT for the first time, no one will ever have an existing VCT so that you can feel “safer” promoting them to clients who already have them!
    Given that, as Phil identifies, these investments should only be recommended to High Net Worth or sophisticated investors because they have maxed out on their pension and ISA investments, we are generally talking about individuals who have mainstream investments into the millions. With these clients, we are crystal clear that only a small proportion of their total portfolio should be considered for such an investment, and the financial plan will detail that this element is not essential for the fulfilment of their lifetime goals.
    Many of the clients with whom we discuss VCT / EIS are attracted to investing as much because they recognise that small businesses need funding if the economy is to succeed, that banks are typically not the best source of funding for these, and that they appreciate the tax breaks mitigate the (higher) risk of losses, rather than investing just for the tax breaks.

  7. Stewart Hutcheson 4th April 2017 at 7:53 am

    There is training & a Diploma offered by EISA in conjunction with Tolley which may be of interest.

  8. Caves? It was a mistake coming out of the oceans… [RIP Douglas Adams]

  9. Whilst I agree with the tax tail and dog principle to some extent, let’s remember WHY the tax breaks exist (to help small businesses attract funding during their growth phase). If chatting with clients I sometimes describe it as “the next step after dragons den!” – though there are some VCTs which are further along the Company growth / establishment path.

    Certainly VCTs aren’t ‘mass market’ but I also feel that they remain overly niche – given that some target 4% tax free dividends we need to consider that for a 40% tax payer that’s equivalent to a 9.5% taxable dividend vs. net investment once the 30% tax relief is also applied.

    With the reduction in the dividend tax allowance and downward pressure on the pension AA there may well be even more scope for VCT – not least for those who run their own businesses who are looking to move capital outside (it’s worth considering that a VCT is arguably less risky than having 100% of your share investments in your own Company/livelihood).

    Also bear in mind that, given that growth is typically paid as dividends, tracking the share price doesn’t in any way reflect the performance of these vehicles given that the dividends, once paid, fall outside of the share price ‘NAV’ performance.

    • You try and get funding from these schemes for a small business. Easier to be invited to Buckingham Palace for dinner. Then look at the many scams. The directors of the VCT or EIS are not infrequently to be found on the boards of the companies they sponsor. They then take directors fees from the recipient company and from the VCT sponsor. Double dipping. Very often they don’t have the first clue about the business in which they are investing. That’s why you find so many schemes investing in placebos for property. You hardly come across any manufacturing firms. Then look at the fees these firms have to pay to the scheme. They must be stark staring mad. One can only surmise that they don’t go to the bank (who often look cheap compared to scheme charges!) because their proposition isn’t robust enough. Then what does that tell you?

      PS. Dragons Den. Should be entitled – how to rip off companies and get away with it. Give away half of your enterprise for a mess of potage.

  10. A different point of view 4th April 2017 at 1:23 pm

    Whilst I agree with the overall message of the article that VCT and EIS schemes should be treated with a high degree of caution from a compliance point of view. I wonder whether Phil knows anything about the two products, as there is a huge difference between the VCT and EIS. For example he mentions six risks of which four are related solely to an EIS.

    I have looked at whether an Investment into a UK Smaller Companies fund is better than a VCT for clients. Despite the Tax advantages of the VCT, the OEIC often wins given the lower charges, higher liquidity and better overall performance and the potential to avoid CGT by making use of the annual exemption each year.

  11. Will use EIS, BPR and VCT schemes for selcted clients.

    It can and does go horribly wrong though.

    Take 2 different EIS from Octopus – their OEIS 1 and PEI7. First one is blamed upon alleged dodgy director dealings and the second one involves a defunct football club calle Glasgow Rangers.

    Losses are in the region 81% of initial investment and 89% of initial investment.

    OEIS1 – initial investment down 81% blamed on the two original external Directors of the 6 Limelight companies (now merged into DTV) whom entered into a number of unsuccessful transactions that were outside the mandate agreed with Octopus.

    Then then there is Octopus PEIS 7 – invested in Ticketus whom loaned money to the now defunkt Glasgow Rangers Plc! Believe it or nor this one is called the Protected EIS. Initial investment down 89%. Persobal guarntees from a shady character called Craig Whtye appear to be worth nil.

    Caveat emptor.

  12. Well choose a company with a good track record, they are not all blood suckers Katz. You people are such a bunch of dweebs, frightened of you own shadow. You deserve the FCA

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