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The UK offers a great range of investment schemes for those looking to maximise returns whilst saving on tax. Two popular options are Venture Capital Trusts (VCTs) and the Enterprise Investment scheme (EIS). Below, our investment team at Bure Valley Group explains how these two schemes work, where they each offer distinct advantages and how they might be integrated into a wider portfolio strategy.
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VCTs & EIS: an overview
These two schemes are often grouped together (also with “SEIS”) due to their intended goal to encourage investment into “riskier”, small and unquoted UK companies.
As a general rule, VCTs tend to be more “diversified” than EIS since an investment is spread over multiple companies. The investor puts their money into the VCT which is, itself, a listed company on the London Stock Exchange (LSE). This VCT then puts investors’ money into a range of unquoted companies which meet VCT criteria.
With EIS, conversely, an investor can invest directly into an EIS-qualifying company (although you can also invest in “EIS funds”, where investors’ money is put into a range of EIS companies on investors’ behalf by fund managers).
Both EIS and VCTs offer investors attractive tax advantages which can increase “real returns” and possibly mitigate losses. Let’s turn to these now, below.
Comparing pros & cons
The main difference between EIS and VCTs is how your money is invested. With a VCT, you buy shares in the VCT. These shares may then rise in value over time depending on how the company’s underlying investments perform.
With EIS, however, you invest directly into the shares of EIS-qualifying companies. Even with EIS funds, the fund managers put your money into direct EIS investments. This means that you have more monetary rights over the EIS shares, but also it is usually harder to make an exit.
Both VCTs and EIS offer tax reliefs to investors, which are fairly similar. Here, it is important to note that these reliefs are only available on the purchase of new shares issued. If you buy any shares on the stock market, relief does not typically apply.
You also must hold shares for a minimum period to qualify for tax relief. For EIS, this is at least 3 years whilst for VCTs it is 5 years. So, be sure that you do not need money you invest in these schemes for at least 3-5 years prior to investing in them.
With VCTs and EIS, you can claim income-tax relief of 30% on newly issued shares. However, EIS has the advantage of letting you carry back tax relief to the prior tax year (provided certain conditions are met). With VCTs, this option is not available.
If you hold your VCT or EIS investment for the minimum holding period, then any capital gains achieved from share disposal are tax-free. EIS investors can also defer CGT payment on the disposal of other assets provided these gains are invested into EIS-qualifying investments.
Dividends are an important difference between VCTs and EIS. With the former, any dividends are tax-fee. However, dividends paid out by EIS are subject to dividend tax.
EIS investments, however, offer “loss relief” equivalent to your highest rate of income tax. VCTs do not let you do this. Also, EIS shares are free from IHT if held for at least 2 years – whilst VCTs form part of the value of your estate when you die.
Implications for portfolio strategy
From this broad picture, it may now be clear that the suitability of VCTs versus EIS depends on a range of factors. First of all, your investment horizon is important. If you might need the money invested in a tax-efficient scheme sooner rather than later, then EIS may be more appropriate given the shorter minimum holding period.
Secondly, your investment goals are important. If you intend to invest mainly for tax-free capital growth, then both VCTs and EIS can offer attractive options. However, if you primarily want to generate an income from your investments, then VCTs may hold the advantage since dividends can be received without tax.
Thirdly, your overall financial plan is important. For instance, are you looking to maximise your returns whilst also mitigating a future inheritance tax (IHT) bill. If so, then EIS shares may be a more important part of your investment strategy due to the IHT exemption on EIS shares after being held for at least two years.
In any case, however, it is important to bear your risk appetite in mind when considering VCTs and EIS. Both tend to offer “higher risk, higher reward” investment opportunities. So, you need to be sure you are comfortable with this before committing to either/both. Here, a financial adviser can help you weigh up your options and consider all relevant information.
Interested in finding out more about the exciting startup projects we have on offer to investors here at Bure Valley Group? Get in touch today to start a conversation with our team and discuss some of the great investment memorandums we have available here:
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