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Technical Briefings

10 February 2010

Venture Capital Trusts and Enterprise Investment Schemes

With tax efficient pension scheme funding seemingly under attack, we take the opportunity to consider whether investing in an Enterprise Investment Scheme (EIS) or Venture Capital Trust (VCT), may be a step towards a solution.

With tax exposure for the successful entrepreneur apparently increasing each year, we take the opportunity to remind you of the potential tax benefits of either Enterprise Investment Scheme (EIS) or Venture Capital Trust (VCT) investments.

For those who are either precluded from obtaining higher rate tax relief on pension contributions, or perhaps are otherwise curtailing pension funding, investments under EIS or VCT may provide some much needed tax relief.

EIS

EIS is a government backed scheme to encourage investment into smaller trading companies. In order to promote such investment, significant tax breaks are on offer, but as usual, there are restrictions as to which businesses will qualify, as well as administrative and other hurdles to negotiate.

EIS can provide three main tax benefits to investors:

An income tax relief at 20%.
Capital gains tax exemption in respect of the EIS shares.
Capital gains tax deferral for any gain made 3 years before the investment (or 1 year afterwards)

The first two benefits are limited to investments of £500,000 per person per annum, but are only available if the investor is not connected with the company. Whilst the connection rules are tightly defined, there are some surprising opportunities to obtain EIS relief in the context of management buy-out transactions.

The investment will need to last at least three years for the investor to retain the tax benefits, so this is not a “short term” consideration. In addition the company must be unquoted (for this purpose ‘unquoted’ includes companies listed on the AIM or Plus Market) and carry on a qualifying business.

VCT

VCTs are professionally managed entities which will invest in a basket of qualifying companies therefore spreading risk more widely than in the case of EIS investments.

Investment in a VCT will attract income tax relief at 30%. Unfortunately, there are no capital gains tax deferral reliefs, but any dividends received from the VCT will be free of tax as will any gains arising when the investment is disposed of.

As with EIS, there are rules to which the VCT fund managers must adhere, and there is a maximum investment per annum – this time £200,000 per person. The minimum investment period in a VCT is five years in order to retain tax relief.

Summary

In conclusion, EIS and VCT can provide significant tax reliefs for individuals, but these are not for the faint hearted. Both investments carry a significant degree of risk, and sound advice from an Independent Financial Adviser should be obtained. Various providers are now offering “lower risk” EIS and VCT opportunities, which aim to retain rather than grow capital, effectively using the tax relief as an investment return.

As a parting note, there is a possibility of obtaining over 40% tax relief from an EIS. For example, if an investor had paid capital gains tax at the old rate of 40%, this could be deferred by making an EIS investment within 3 years.

When the gain comes back into charge, this will be at the current 18% capital gains tax rate, representing a saving of 22%. Add this to the 20% income tax relief, and the overall saving becomes 42% - not to mention a tax free sale of the EIS shares, should they be sold at a profit!