It may come as a surprise to many how long both venture capital trusts (VCTs) and enterprise investment schemes (EISs) have been around. Introduced in the mid-1990s, when the investment landscape looked very different to that of today, many of the other vehicles around have since been replaced, merged or forgotten. But VCTs and EISs remain.
And although both started out as esoteric investments for wealthy investors, they are now perceived as well established. Mainstream, even.
Their popularity is understandable at a time of restricted pension contributions and increasing tax bills. However, the need for advice is vital to help make clients aware of the risks of investment, timing and liquidity.
There is a danger when assessing VCTs and EISs together as it perpetuates the myth they are interchangeable. While understandable, given they both invest in similar groups of underlying companies with similar qualifying characteristics, VCTs and EISs are very different in their structures and the tax breaks they offer.
A cursory glance at tax breaks, maximum investment amounts and minimum holding periods could lead to a conclusion EISs are the better option.
Clients invested in EISs need only hold their investment for a minimum of three years and can invest up to £1m per tax year. They can receive 30 per cent upfront income tax relief, which can be carried back to the previous tax year if required and receive capital gains tax deferral. The investment will qualify for business relief after being held for two years, putting it outside their estate for inheritance tax purposes.
Take a closer look
In contrast, clients in VCTs need to hold their shares for a minimum of five years to claim the same 30 per cent upfront income tax relief. They receive tax-free dividends from successful realisations or income generated from within the VCT but do not benefit from CGT deferral relief or business relief. VCT investors are limited to a maximum investment of £200,000 in each tax year without the ability to carry an investment back to the previous tax year. Indeed, on the surface, the EIS wins hands down. However, a closer look at the subtler differences between the two show the need for advice.
While the tax benefits of an EIS might be greater than those available under a VCT, whether they are better in practice depends upon if the investor needs or can use such benefits.
If the primary requirement is income tax relief, VCTs offer clear advantages in terms of speed. VCT investors can generally claim tax relief on investments within two weeks of shares being allotted. The process for an EIS investment is far more complicated.
Once shares in the EIS company are issued, the company must trade for a minimum of four months before the EIS1 certificate can be submitted to HM Revenue & Customs, which may take several months to create EIS3 certificates needed for investors to claim initial tax reliefs. If the investor does not have a capital gain to defer or is not looking for an asset that is potentially IHT exempt, these EIS benefits will have little to no value.
VCTs and EISs also differ structurally. VCTs are similar to an investment trust, with a board of directors, regular reporting and a listing on the London Stock Exchange. This exposure can balance out some volatility seen in the value of smaller companies over an economic cycle, while potential upsides from a manager backing a successful company can be counterbalanced by businesses that underperform.
While VCTs benefit from some level of diversification, EISs are not collective investments but rather investors are direct shareholders in an unquoted company. Even though EIS portfolio services exist, splitting funds across a number of EIS companies, the diversity and spread of investments will be narrower than a VCT investment.
There is no simple answer on which vehicle to invest in. VCTs will be better for some clients and EISs for others. Both have potential to play different roles in any portfolio, giving access to different levels of income and risk while producing distinct benefits over different timelines.
This is clear when exiting investments: VCTs are often used over a seven- to nine-year investment horizon while EISs probably have a five- to seven-year timescale.
These differences are complex and reinforce the importance of advice. Advice is especially important given recent changes to VCTs and EISs which, in a shifting economic and regulatory environment, have seen tax relief change, along with variations in the type of investments they are permitted to make.
Tony Mudd is divisional director for development and technical consultancy at St. James’s Place