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Spot the difference

Gordon Brown’s Budget changes have made choosing whether to invest in VCT or EIS a great deal more difficult

I understand that the Chancellor made some changes in the last Budget that affected both Venture Capital Trusts and the Enterprise Investment Scheme. These changes, I believe, may make choosing between the two schemes more difficult. Can you outline the main changes and how the schemes compare?

You are quite correct in stating that the attractiveness of a VCT when compared to an EIS is now less obvious. The two schemes offer attractive tax incentives to encourage investment, but care needs to be taken in deciding which is the more suitable for you.

It is probably best to just go over the main tax rules for each and highlight the changes introduced in this year’s Budget.

The Enterprise Investment Scheme is a Government scheme that allows certain tax benefits for investors who invest (i.e. subscribe for qualifying shares in qualifying companies).

There are a number of EIS tax benefits that might appeal to you:

Income tax. As long as you do not hold more than a 30% interest in the company, you can reduce your income tax liability by an amount equal to 20% of your investment into the EIS. The maximum amount that you can invest was increased in the last Budget to £400,000 per annum, so, assuming you had sufficient income, you could make an EIS investment of £400,000 in this tax year and receive £80,000 of income tax relief.

Capital gains tax deferral (of gains realised on a different asset) is also available, where disposal of that asset was less than 36 months before the EIS investment or less than 12 months after it. This relief is not limited to investments of £400,000 per annum and can be claimed even if you hold more than 30% of the company. This means that if you have made a capital gain within the last three years (or if you expect to make one within the next year), you can defer paying the capital gains tax by investing inan EIS. You should note that deferral of gains is no longer available by investing in VCTs, so if CGT planning is your main aim, then an EIS may well be the most suitable vehicle for you.

There is also no capital gains tax payable on disposal of the EIS shares after three years, provided the EIS initial income tax relief was given and not withdrawn on those shares. Also, if the EIS shares are disposed of at any time at a loss, the loss can be set against either any of your capital gains or your income in the year of disposal.

You should once again note that the offset of losses is not available by investing in VCTs.

Inheritance tax – your EIS investments are exempt from inheritance tax after you have held the investment for two years as shares in such companies attract a 100% business property deduction for inheritance tax purposes. This is another advantage of an EIS as the exemption from IHT is not available by investing in VCTs.

Finally, one negative introduced in the last Budget was the ‘gross assets limit’. For EIS companies this was reduced to £7m (from £15m). This means that for the company to qualify for EIS relief, it must not have gross assets in excess of £7m prior to the EIS investment being made.

Having discussed the main tax advantages of VCTs, I will now focus upon the main changes to VCTs, introduced in the last Budget:

A new 30% rate of income tax relief was introduced for investors from 6 April 2006, having been reduced from 40% in the 2005/2006 tax year.

The minimum holding period for VCT investors is now five years for investments made on or after 6 April. This had previously been a three-year minimum holding period.

For Venture Capital Trusts, the new gross asset test limits of £7m (as referred to above) apply.

So, in summary, following the Budget, many commentators now feel that choosing between VCTs and EISs needs to be considered carefully, because:

They are both now likely to be investing in ‘higher risk’ companies (due to the reduction in the gross assets test).

VCTs offer a 30% income tax benefit, whereas EISs only offer 20%

VCTs need to be held for a longer period in order to retain the Income Tax benefit (i.e. five years instead of three years for an EIS).

There is no CGT deferral benefit by using a VCT, but there is if using an EIS.

It is possible to offset any losses incurred by investing in an EIS, but not by investing in a VCT.

It is possible to reduce your IHT liability by investing in an EIS, but not by investing in a VCT.

Patrick Murphy is Director of Investment Management Services at Thinc Destini

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