A surprise boost for start-ups

Tightrope-walking businessman © Getty images
The Budget will prod investors into riskier acts

Long-term savers are breathing a sigh of relief following last week’s Budget: not only did pensions tax relief escape the chop despite warnings of cuts, but investors in tax-efficient venture-capital trusts (VCTs) and the enterprise-investment scheme (EIS) also got an unexpected boost.

VCTs and the EIS provide people with valuable tax breaks to encourage investments in small, unquoted companies where there is a substantial risk of investors losing their capital. However, ministers have become anxious that some of the companies that currently qualify for inclusion in the schemes’ portfolios are actually very low risk – and therefore shouldn’t need tax incentives to attract funding. As a result, the chancellor plans to introduce more generous investment limits for both schemes.

First, from the April 2018-2019 tax year onwards, investors in the EIS will be able to invest up to £2m a year, twice as much as the current limit, as long as their additional contributions go into “knowledge-intensive” companies – broadly, those businesses where a significant proportion of cost is accounted for by innovation and research and development. The change means the wealthiest investors will qualify for tax relief of up to £600,000 a year from the scheme.

The contribution limits for VCT investors, meanwhile, will remain the same, but the funds will in future be permitted to invest up to £10m in each knowledge-intensive company in the portfolio, up from £5m previously, giving managers more investment options. The quid pro quo for these concessions is a test that will prevent the schemes putting money into less risky assets.

Many in the industry had expected the generous tax treatment of both schemes to be curtailed, particularly as VCTs and the EIS are now seen as potential alternatives to private pensions, where tough caps on contributions are hitting wealthier savers’ ability to invest as much in retirement plans as they would like. Consequently, EIS and VCT managers have given the Budget changes a cautious welcome, though the government has yet to provide details of its crackdown on low-risk assets. On the right we look in more depth at how VCTs and the EIS work.

How do the schemes work?

Although venture-capital trusts (VCTs) and the enterprise-investment scheme (EIS) sound fairly complex, it’s worth being aware of the tax benefits they offer. Both VCTs and the EIS are limited to investments in unquoted companies, though some Aim-listed businesses qualify, if they have assets of no more than £15m before the investment, and no more than 250 employees.

VCTs are listed collective funds of qualifying businesses. Investors get upfront tax relief of 30% on VCT investments up to £200,000 a year, as long as they buy newly issued VCT shares and hold them for five years; in addition, all subsequent dividends and capital gains are tax-free.

The EIS, on the other hand, is an unquoted vehicle. Investors can put their money into a single qualifying company or buy in through a portfolio service run by a manager, up to a maximum annual investment of £1m, rising to £2m in 2018-2019. Investors get most of the same tax reliefs as those offered by VCTs, though income is taxable. EIS investments are also exempt from inheritance tax after they’ve been held for two years, and can be used to defer capital-gains tax due on the proceeds from other investments.

The Budget’s stealth tax on savers

As many as ten million people stand to lose out from Budget small print that will add to the tax bills of insurers. The chancellor’s plans to abolish the “corporate indexation allowance” in January will mean losses for savers who have with-profits savings plans run by insurers; millions use such plans to save for retirement, provide life insurance, or to underpin endowments (regular savings plans that pay out a lump sum at the end of a set period) linked to their mortgages.

The corporate indexation allowance effectively enables a business making investments to write off the corporation tax due on the part of the profit it makes that could be attributed to inflation. So a company with an investment that returns, say, 6% during a year when inflation averages 3%, would only be liable for tax on half the profit.

Insurers’ with-profits funds are technically insurance policies and therefore fall within the definition of businesses making investments; and while the tax theoretically falls due on the insurer, it is standard practice among with-profits providers to pass such costs to investors. This cost will probably only amount to £50 per year, but given the number of people potentially affected, the measure will raise substantial sums overall. Ministers forecast an amount of almost £1.8bn over the next five years, prompting accusations that the change amounts to a stealth tax on savers.

Tax tip of the week

Homeowners who benefit from the “rent-a-room” tax break while renting out rooms on a short-term basis via services such as Airbnb and Spareroom might not be able to use it for much longer, warns The Sunday Times. Under the tax relief, people can earn up to £7,500 from renting out a room in their house before having to pay income tax on the income.

However, in a “line buried in last week’s Budget”, the government said it would call for evidence to establish how the allowance is used “to ensure it is better targeted at long-term lettings” (the scheme’s original purpose was to increase the supply of affordable long-term lodging). The Treasury denied that it intended to restrict the scheme.