The Enterprise Investment Scheme (EIS) and Venture Capital Trust (VCT) both offer distinct pros and cons from an investor’s perspective. They seek to offer an alternative investment route from traditional public markets, combined with compelling tax benefits.
Understanding the key differences between EIS and VCT is crucial for investors looking to diversifying their portfolio, put investment towards innovative startups whilst also mitigating their risk exposure. Here, we will outline how the two compare to help you inform your thinking.
Please note that this content is for information purposes only, and should not be taken as financial or investment advice. Capital is subject to risk and you may get less money back from your investment, compared to what you originally put in.
Overview: How EIS & VCT got here
The past decade has seen a rapid increase in the EIS and VCT markets, during which time both have almost doubled in size.
EIS was launched by the UK government in 1994. Since then, over 27,000 businesses have received funding via the scheme. Over £18bn is estimated to have been raised and costs to the treasury are estimated at over £3bn (in the form of tax relief), yet the return in the form of new jobs is likely to benefit government revenues in the longer term.
VCTs were started at around a similar time, in 1995. Since that time, under this scheme, nearly £7bn has been raised from investors.
There are many reasons for this growth in the EIS and VCT markets, but undoubtedly a big factor has been important changes in the world of pensions.
For instance, it wasn’t too long ago that you could put over £250,000 towards a pension each year. In 2019-20, however, this annual allowance has been reduced to £40,000. For those on higher incomes, the allowance is even lower.
Successive governments have also been keen to encourage growth and innovation amongst UK startups, to drive growth in the wider economy. As we will see now, EIS, in particular, was set up with this purpose in mind.
How EIS & VCT compare
A Venture Capital Trust (VCT) is essentially a publicly-listed company which contains a fund manager, who invests your money and others’ into smaller businesses which are not publicly listed on primary stock exchanges.
One important feature of VCTs which makes them attractive to investors is the tax relief on offer.
When you buy newly-issued VCT shares, for instance, you can claim up to 30% Income Tax relief on the amount which you invested. The main condition here is that you need to hold the VCT shares for at least 5 years to keep the tax relief.
Moreover, if you do eventually decide to sell your VCT shares then any profit you have made from the sale should not be subject to Capital Gains Tax.
That’s not all, however. Any dividend income you make from VCT shares is not subject to Income Tax either and does not need to be declared on your Self Assessment form.
You can put up to £200,000 into VCTs per financial year, in 2019-20.
An enterprise investment scheme (EIS), on the other hand, is not a “company” (like a VCT). Rather, it refers to a collection of tax reliefs offered to investors by the UK government, when they choose to invest in companies which qualify for EIS status (particularly start-ups).
Similar to VCTs, however, you can claim up to 30% Income Tax relief on an EIS investment. So if you commit £20,000 towards EIS-qualifying firms in a given financial year, for instance, then you “save” yourself £6,000 in the form of Income Tax relief.
In another echo to the structure of VCTs, you must hold your EIS shares for a minimum of 3 years to claim the tax reliefs on offer.
You can invest up to £1m per financial year in EIS-qualifying companies, provided you are not connected to any of them (e.g. via family ties) and provided you are a UK taxpayer.
One of the powerful allures of EIS to investors is the “EIS loss relief” mechanisms. This allows you to claim back some of the value of your original investment, in the event that it fails. The percentage you can claim back is equal to the highest rate of Income Tax which you pay.
Imagine, for instance, that you invest £10,000 towards an EIS-qualifying company but it fails. First of all, you claim back 30% in the form of Income Tax relief – meaning £7,000 of capital is, in fact, at risk (not £10,000). Then, you claim back 45% of the value of your at-risk capital (since 45% is the highest Income Tax rat which you pay). So, 45% of £7,000 is £3,150 – which means that you have only lost £3,850 rather than £10,000.
VCT vs. EIS: Which is better?
Clearly, both options provide powerful routes for investors to commit their wealth. Both offer significant tax reliefs, for instance, which are hard to replicate elsewhere.
It is probably fair to say that VCTs and EIS are more suitable for particular investment strategies. For instance, VCTs can be attracted to higher-rate taxpayers who are seeking a supplementary, “top-up” income during their retirement. This is because VCT returns are typically paid to investors in the form of dividends, which are not subject to tax.
From an investment perspective, however, EIS clearly has an important advantage in the form of loss relief – offering substantial downside protection to EIS investors, whilst allowing you to take advantage of the investment upside potential. EIS can also be a powerful tool within a wider estate planning strategy. This is because EIS investments are not usually subject to inheritance tax once they have been held for a minimum of 2 years.
Here at Bure Valley Group, we focus on offering investors a selection of exciting EIS and SEIS-qualified investment opportunities. To browse our latest projects, we invite you to take a look at our portfolio here.