Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EIS) explained

Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EIS) have always been a grey area for investors. Warned off by the ‘at your own peril’ signs put up by the FCA, many people have been frightened off by the level of risk they would have to take, despite returns being pretty decent.

In their essence, VCTs and EISs are investments in small companies that attract tax reliefs. And it’s because the investment is in small companies that the risk is significant. Obviously, the general rule of thumb in investing is the bigger the business, the less likely it is to fail.

One of the key things to bear in mind when opting to take the EIS/ VCT route is its manager. Generally, the managers who focus on more mature businesses so as to mitigate risk, target yield for a tax-free income, have a clear exit strategy and a proven track record are the managers to opt for. They should also sufficiently diversify your holding, taking your existing portfolio into account.

What are the different types of EIS and VCTs?

Generalist EIS/ VCTs are the managers who have a truly private equity background and look for qualifying investments across the whole market. These managers will often take board positions on AIM. A specialist manager is just that – one that focuses on a specific sector, like media. Some managers look to return total value to investors as close to the minimum holding period as possible (five years for VCTs and three for EISs) by selling the underlying assets and making payments to investors through tax free dividends (VCT) and capital gains, which are tax free (EIS) – these are referred to as ‘Limited Life investments.’ There are also AIM specific VCTs and EISs.

Why are VCT/ EIS such tax efficient investments? 

Both VCT/EIS have different tax treatments, but both are beneficial from a tax perspective for canny investors who want to reduce their tax liability. With VCTs, investors can enjoy 30% income tax relief on investments up to £200,000 in a tax year, subject to the five-year retention of shares. When selling an investment in the UK, any capital gains generated are tax-free and dividends are paid without further tax liability. Additionally, VCTs themselves are not subject to corporation tax on gains or distributions from UK companies. Regarding EIS tax features, investors can see 30% income tax relief on investments up to £1m each tax year, subject to a three-year retention and can carry back to the previous year if the relief is unused. A particularly good feature is that EIS can defer capital gains tax if a gain has been cashed in realised in the last three years, or the subsequent 12 months. Finally, with EIS investments, investors can enjoy 100% IHT relief after a two-year holding period.

It all looks pretty rosy doesn’t it? What’s not to love? Well, the price you pay for investing in VCTs/ EISs is swallowing that significant spoonful of risk. As we said earlier, smaller often means riskier in investing terms, particularly where start ups are concerned. Liquidity is another risk factor – you might have difficulty selling these investments at a reasonable price and sometimes it might be difficult to sell them at any price. The lack of visibility is another issue, where it may be tricky to obtain reliable information about the value of the companies or the extent of any risks they may be exposed to. There is also a risk with the manager – if they don’t stick to the rules, they forfeit tax relief. VCT/ EIS are also often criticised as some are not regulated by the FCA and therefore don’t guarantee the protection to investors that other investments might.

There are other risks. And investors considering an EIS or VCT investment really have to be aware of the risks of this asset class. If you’re thinking about it, it’s highly likely you’ll need professional help to understand the nature of the investment and whether that level of risk suits your profile. But for those investors who are prepared to contemplate riskier investments, the tax relief and the returns investors have realised in the past definitely warrant a second look. But the ‘at your own peril’ signs, might mean that you need your armbands.

Speak to an VCT/EIS expert

If you would like to know more about VCT/EIS investing, please get in touch with one of our experts.

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Investments in VCTs and EISs should be regarded as high risk as they invest in small companies with shares that are highly illiquid and can be hard to sell. They are only suitable for UK resident taxpayers who can tolerate higher risk and have a time horizon of greater than five years. They attract tax reliefs provided the underlying managers keep to certain rules.

The tax treatment of all investments depends upon individual circumstances and the levels and basis of taxation may change in the future. Investors should discuss their financial arrangements with their own tax adviser before investing.

The tax treatments set out in this communication are based on our current understanding of UK legislation. It is a broad summary and cannot cover every circumstance and it does not constitute advice.

The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity.