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In 2023, some interesting research has shed light on UK financial advisers and the tax-efficient investment “vehicles” they like to recommend to their clients. The findings show that advisers prefer the Enterprise Investment Scheme (EIS) to Venture Capital Trusts (VCTs).
Below, we explore why this preference may exist amongst advisers and what the implications might be for early-stage investors. We hope these insights are useful to you. To learn more about our EIS projects and other early-stage opportunities, visit our portfolio page here. For enquiries regarding our latest projects and funding, you can reach us via:
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The IHT-saving potential of EIS
When clients of financial advisers reach a particular stage in their financial journey – e.g. complex estates with multiple assets potentially liable to tax – the conversation can turn to investment options such as EIS and VCTs. Both schemes offer generous tax advantages to investors whilst opening the potential for higher returns (albeit at higher levels of risk).
Take an individual who is 70 years old, single and owns a £3m estate. She hopes to pass her property and possessions down to her children when she dies. Yet everything she owns is far above the tax-free threshold for inheritance tax (IHT).
In 2023-24, you can normally pass down a £325,000 estate to beneficiaries without IHT. This can be “extended” to £500,000 using the Residence Nil Rate Band (RNRB) if the family home is left to children or other direct descendants. Yet, for someone with a £3m estate, what are the options for keeping maximum wealth within the family?
Enter EIS. One of the great benefits of the scheme is that EIS shares are exempt from IHT if held for a minimum of 2 years. So, in the individual’s case above, she could “shield” her estate from IHT if she invested a significant portion of her wealth in EIS.
An investor can invest up to £1m into EIS companies each tax year (or, up to £2m if the companies are deemed to be “knowledge-intensive”). So, over two or three tax years, the individual could create an IHT-free estate plan using tools such as the RNRB, gifts, trusts, EIS and other tools like holding AIM shares (alternative investment market) within an ISA.
By contrast, VCTs do not qualify for IHT relief. Even if the underlying investments of a VCT are classed as AIM shares (which normally do quality for the relief), the VCT structure itself does not. This is likely a key reason driving advisers in steering clients towards EIS, not VCTs.
EIS and VCTs compared
The above is not to suggest that VCTs have no place within an investor’s portfolio. Indeed, depending on the investor’s goals and circumstances, they may even be preferable to EIS in certain cases. In particular, VCTs offer tax-free dividends. This can be especially attractive to income investors, who do not even need to declare the income on their tax returns.
Moreover, capital gains generated from VCTs are free from capital gains tax (CGT). Similar to EIS, VCTS also offer up-front income tax relief up to 30% and the typical minimum investment is lower at £3,000 (rather than £25,000+).
Yet VCTs do suffer some drawbacks compared to the benefits on offer from EIS. In particular, the maximum investment limit is set at £250,000 rather than £1m/£2m for EIS. The minimum holding period, for HMRC, is also longer at 5 years for VCTs compared to 3 years for EIS. The latter offer “loss relief” equivalent to the investor’s highest marginal rate if an EIS investment fails, whilst VCTs have no such mechanism.
EIS arguably offers more investment choice to investors than VCTs. The former lets investors build direct ownership in individual EIS companies which are suitable for their portfolios. The latter is a type of “active fund”; itself a listed company invested in multiple early-stage companies on behalf of investors.
One potential advantage of VCTs is that they have an impressive amount of “in-built diversification” with 20, 100 or even more companies held within the VCT itself. However, a prudent EIS investor can still build a very diversified early-stage portfolio by incorporating a range of markets, business models and lifecycle stages into his/her EIS selection.
Weigh the risk carefully
Whilst financial advisers seem to prefer EIS to VCTs when offering guidance to clients, this is not to say that EIS is always offered by such professionals. Indeed, it is likely fair to say that most adviser clients will not be recommended either option due to the investment risk.
Although investors can take certain steps to protect their portfolios from EIS volatility – e.g. diversifying and taking advantage of loss relief – there is still, typically, a higher risk to an investor’s capital with EIS compared to certain other types (e.g. publicly-listed stocks with a stable price history). Investors need to weigh these risks carefully, understand them and ensure they are comfortable before making a commitment.
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