We're delighted to present an article written by Martin Sherwood, a co-founder and board member of the Enterprise Investment Scheme Association, on tax efficient investing
Our approach is simple: transparency, quality and full service. We only work with high-calibre asset managers and management teams to provide quality investment opportunities for our investors.
Martin Sherwood, Founder, Enterprise Investment Partners
Get Your Free Guide To Tax Efficient Investing Below, Which Outlines The Seven Key Areas To Consider When Reviewing Tax Efficient Investments
Tax Efficient Investing
As we approach the final quarter of the tax year, now’s the time to consider your tax position and explore the various investment opportunities which might offer both a profitable return and a reduction in your tax.
You should consider Venture Capital Trusts, Enterprise Investment Schemes, Seed Enterprise Investment Schemes and lastly, Business Property Relief Schemes which provide exemption from Inheritance Tax and are particularly appropriate for older people seeking to protect their wealth for future generations.
Tax Efficient Venture Capital Trusts (VCT)
VCTs are 20 years old and a proven vehicle for tax efficient vehicle for many. VCTs are fully quoted companies which invest in a portfolio of small and growth businesses which carry on a trade which qualifies for relief. Most normal trades do, with a few exceptions like financial or professional services. You receive 30 per cent Income Tax relief on your investment – so, if you invest £10,000, you will receive a rebate or discount on your Income Tax bill. All dividends during the life of the VCT will be tax-free, and all disposals after five years will also be free of tax. However, VCTs are not Inheritance Tax (IHT) efficient and will be subject to 40 per cent IHT on death, so you should plan to dispose of them once you’re over a certain age.
Tax Efficient Enterprise Investment Schemes (EIS)
EISs offer the most extensive range of tax benefits:
- Up-front Income Tax relief of 30 per cent. So if you invest say £10,000, you receive a discount or credit of £3,000 against your income tax liability for the current year, OR it can be carried back to the prior year.
- If you have a Capital Gains liability, this can be deferred or frozen for the lifetime of your EIS investment.
- Any gains you make on your EIS investment will be free of tax on disposal. So, if your £10,000 investment is worth £20,000 on exit, you will have made a tax-free profit of £13,000 on your net investment of £7,000.
- Should the investment not be successful, you will be eligible for loss relief on your net cost at your highest marginal tax rate. This could be worth up to £3,150 on a £10,000 investment (45 per cent of the net cost of £7,000).
- And finally, in the event of death, the investment falls outside an estate for tax purposes once the shares have been held for no less than two years.
It is important to be aware that the EIS rules are enshrined in law, so there is little or no chance of a challenge from HMRC to pay the tax relief back. That can only happen if the EIS company in question is in breach of any of the EIS rules. So do not confuse VCTs and EISs with the notorious partnership schemes of recent years which have been the subject of so much media coverage on account of “tax avoidance”.
Tax Efficient Seed Enterprise Investment Schemes (SEIS)
SEISs were introduced 4 years ago by Chancellor Osborne in order to stimulate investment in very small start-up businesses. They provide 50 per cent income tax relief compared with 30 per cent for EISs, so immediately attracted a substantial level of support. They now represent over 10 per cent of the amount raised annually by the combined EIS and SEIS markets. There is a low limit of £150,000 on the amount of money a SEIS company can ever raise, which means the level of risk tends to be much higher. SEIS is best approached on a portfolio basis, where your funds are being invested by an experienced manager, who not only can identify suitable investments but also provide support and nurturing for the entrepreneurs.
So what should you look for in an EIS or SEIS? These in my view are the most important considerations:
- Track record of the manager: How many previous EIS exits has the manager achieved, and what’s the average return across all of them?
- Commitment: Has the management invested their own money in the business?
- Transparency: How clear is the investment proposition? How willing is the manager to explain the concept and provide further information?
- Ease of exit: Don’t forget EISs are unquoted companies and can’t usually be sold until an exit has been found, most often by way of a trade sale. How easy will this be?
Recent changes in the EIS rules are having the effect of reducing the number of “artificial structures” and early exit schemes available and are favouring businesses carrying on genuine trades. There are now broadly three types of scheme:
- Lower Risk Schemes where there is a degree of “downside protection” – the converse is that the potential uplift in value may not be very high.
- Growth Schemes where there is trading risk but this is mitigated by a degree of asset-backing and the presence of a highly professional management team.
- “Super Growth Schemes” which is obviously the highest risk end of the market, but equally the highest reward.
Tax Efficient Seed Business Property Relief Schemes (BPR)
The BPR market has now overtaken the EIS market in size and is continuing to grow in popularity. These are schemes or companies which carry on a normal UK trade which offers a high degree of predictability: a good example is the generation of solar power, which still benefits from Government subsidy and whose performance is highly predictable and will usually not vary outside of a tight band of 10 per cent on an annual basis.
Annual returns of 5 to 7 per cent may be achievable and most schemes offer a reasonable level of liquidity in the event cash is required to fund the cost of care. The key attraction of these schemes is their exemption from IHT after two years from the date the shares are issued. Far too few people realise that the current Nil Rate Band stands at £325,000 per individual (£650,000 for couples) and that everything above this level will probably be subject to a swingeing 40 per cent.
For older people, progressive conversion to tax efficient vehicles should be the norm and not the exception.
So, good luck with your investment selections!
Free Guide To Tax Efficient Investing
If you're considering making a tax efficient investment, please complete the form below. We'll be delighted to email you an informative white paper which discusses the seven key areas you should consider before making your tax efficient investment. And we'll provide you with Martin's contact details so you can have your specific questions answered by an expert.
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The value of tax efficient investments, and the income derived from them, can go down as well as up and you can get back less than you originally invested. This is not advice to invest, or not to invest. Venture Capital Trusts, Enterprise Investment Schemes, Seed Enterprise Investment Schemes and Business Relief Schemes should all be regarded as high risk investments. They are only suitable for UK resident taxpayers who can tolerate higher risk and have a time horizon greater than five years. This page does not constitute personal advice. Prevailing tax rates and reliefs are dependent on your individual circumstances and are subject to change. If you are in any doubt as to the suitability of a tax efficient investment, please seek the advice of a suitably qualified independent financial adviser. SIPPclub does not provide legal, financial or tax advice of any sort. Advice in relation to Inheritance Tax planning is not regulated by the Financial Conduct Authority, but the products used in relation to trusts and to mitigate tax may be regulated.