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."
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.
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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.
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.
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.
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David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.
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