VCTs, EIS and SEIS: tax relief for brave investors

If you can stomach the risk involved in backing a company in its early stages, consider VCTs, the EIS and the SEIS. Generous tax breaks are on offer.

938_MW_P38_ISA_VCTs

Investors being urged to use Isa and pension allowances before the end of the tax year may not realise there are even more valuable tax incentives available assuming they're prepared to accept additional investment risk. Alex Davies, the chief executive of Wealth Club, a specialist adviser on tax-efficient investments, calculates that the tax reliefs on offer from three other tax-efficient investments are together worth £724,000 this year.

"Venture capital trusts (VCTs), the enterprise investment scheme (EIS) and the seed enterprise investment scheme (SEIS) are bastions of tax-efficient investing where investors can shelter their wealth," Davies says. "If an investor takes up their full annual allowance in each, they could claim up to £710,000 back in income-tax relief. The bill from any capital gains made in the same tax year can also be halved, giving an investor up to another £14,000 on top."

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

All three schemes were launched to fund early-stage companies that often struggle to raise capital. The firms aren't usually listed on a stock exchange, though certain Alternative Investment Market (Aim) shares do qualify.

High potential returns and higher risk

Get these investments right and the returns can be attractive, even leaving aside the tax benefits. The average generalist VCT, for example, has delivered a 140% total return over the past decade, according to the Association of Investment Companies (AIC). Moreover, as VCTs, the EIS and SEIS invest in very different types of company to traditional Isa and pension funds, they can also offer valuable diversification benefits. Nevertheless, tread carefully. Even with a strong past performance record and decent tax breaks, the high-risk profile of these shelters means they're only suitable for a small chunk of your overall portfolio.

Advertisement
Advertisement - Article continues below

Research by the Harvard Business School suggests that up to 40% of start-ups that raise capital end up failing completely, while another 40% only manage to return investors' stakes. Just 20% of these businesses deliver a positive return on investment. Against that, however, VCTs are collective funds offering exposure to a portfolio of companies, which mitigates risk. What's more, their managers can leave up to 30% of funds invested in risk-free cash. EISs can also be structured as collective funds. And, of course, the tax relief on offer helps soften the blow of portfolio failures.

This relief really is very generous. To begin with, you can invest £200,000 each tax year into new shares issued by a VCT, claiming 30% income-tax relief upfront (though you can't claim more income tax than you owe). All income and capital gains from a VCT, moreover, are tax-free.

The EIS, meanwhile, offers an annual allowance of £1m, or £2m for investments in "knowledge-intensive" companies with a heavy emphasis on research and development. Like VCTs, the EIS offers 30% upfront tax relief and tax-free capital growth. In addition, investors can set any losses they incur against their tax bills. Furthermore, EIS investments don't count towards inheritance tax once you've owned them for two years. Finally, the SEIS has an annual allowance of £100,000, but offers a whopping 50% upfront income-tax relief, as well as the same capital growth and inheritance tax reliefs as the conventional EIS.

How to choose a scheme that suits you

Which scheme should you opt for? VCTs and the EIS invest in companies of a similar size. These must normally be worth less than £15m, have fewer than 250 employees and be less than seven years old. VCTs are collective funds run by professional managers on investors' behalf; by contrast, individual companies raising capital can apply for EIS status and then offer their shares to investors, though a number of brokers also run managed EIS portfolios. To qualify for SEIS inclusion, meanwhile, a company must have traded for a maximum of two years, have assets of less than £200,000 and fewer than 25 employees. These are substantially riskier than the businesses in VCT and EIS portfolios, hence the generous tax relief.

As for choosing individual investments, the key is to do your homework.With VCTs, look for a manager with a strong record of generating good returns from funds in the sector. You don't qualify for the upfront tax relief if investing in VCT shares already listed on the stockmarket only new shares carry this benefit so you can't simply invest in an existing fund. However, past performance data on the AIC website will still give you an idea of which VCT managers have done well.

But ensure you're comparing like with like. Some VCT managers specialise in generalist funds comprising companies from a range of industries. Others focus on a particular segment of the market, such as Aim. Picking EIS investments can be more difficult, particularly if you're investing in individual companies rather than a managed portfolio of qualifying companies chosen for you by a professional. If the former, only invest after you have thoroughly researched the business and build a portfolio of EIS companies rather than putting all your eggs in one basket. Look for EIS managers with a strong track record and affordable charges.

Advertisement
Advertisement - Article continues below

The SEIS, by contrast, isn't available in any form of managed portfolio you really are on your own. That raises the stakes on due diligence: do detailed research and don't invest cash that you can't afford to lose.

Advertisement

Recommended

Visit/520181/how-the-fear-of-death-affects-your-investment-process
Investment strategy

How the fear of death affects our investment processes

Many of our investment decisions are driven by one simple fact: the knowledge that, one day, we will be dead. Here, in an extract from his new book, J…
2 Jan 2020
Visit/520060/the-good-and-the-bad-investments-of-2010s
Stock markets

The good investments of the 2010s – and the bad

John Stepek takes a look back on which investments did well and which did badly in the decade that’s about to come to an end.
26 Dec 2019
Visit/519223/how-can-we-raise-more-money-in-tax
Economy

What are the best ways of raising more money in tax?

Given that whoever wins next week's election will be going on a massive spending spree, we're going to need to raise at least some of that money throu…
5 Dec 2019
Visit/518715/what-are-the-biggest-mistakes-investors-make-when-it-comes-to-tax
Investment strategy

What are the biggest mistakes investors make when it comes to tax?

The tax implications of an investment are something we rarely consider until after the event. That could prove to be an expensive mistake, says Domini…
27 Nov 2019

Most Popular

Visit/investments/commodities/gold/600686/gold-and-silver-bull-market-2020
Gold

Want to make money in 2020? Gold and silver are looking like a good bet

If you want to make money from investing, says Dominic Frisby, it’s simple: find a bull market and go long. And in 2020 gold and silver are in a bull …
22 Jan 2020
Visit/economy/600691/money-minute-friday-24-january-the-key-to-uk-interest-rate-cuts
Economy

Money Minute Friday 24 January: the key to UK interest-rate cuts

Today's Money Minute looks ahead to the release of data that could hold the key to UK interest rates cuts. 
24 Jan 2020
Visit/economy/600690/money-minute-thursday-23-january-european-interest-rates
Economy

Money Minute Thursday 23 January: European interest rates

In today's Money Minute we look ahead to Christine Lagarde's second interest-rate-setting meeting at the European Central Bank.
23 Jan 2020
Visit/investments/funds/600697/how-the-boom-in-passive-investing-could-create-better-run-companies
Funds

How the boom in passive investing could create better-run companies

ESG investing, or "ethical investing" as it used to be called, is mostly about the marketing, says John Stepek. But it's not all bad.
24 Jan 2020