Exploring EIS And VCT's: Worth The Hype?

If you're in the personal finance space, chances are you've heard of EIS (Enterprise Investment Schemes) and VCTs (Venture Capital Trusts), which were launched in 1994 and 1995 respectively. Everyone keeps talking about them, and you’ve heard about the extreme tax relief you can take advantage of, but you've also heard that they are a risky investment, so you strayed away from them. In our first newsletter issue, we’re going to break them down, find out the differences, and hopefully give you a clearer view of what they offer and how they work.

Image Credits: David Vincent via Unsplash

EIS and VCTs Breakdown

Enterprise Investment Schemes and Venture Capital Trusts are investments made into smaller companies hoping to raise capital in the early days of being incorporated.

The government set these schemes up to boost the economy by allowing smaller businesses access to vast amounts of capital that they would otherwise not have had access to and, in turn (if successful), drive up productivity and create jobs, strengthening the economy.

EIS and VCT investments are often used by those who have maxed out their ISA and pension contributions for the year, which are also similarly tax-effective. The government acknowledges the risk to investors, so in turn offers some attractive tax benefits.

How Tax Effective Are They?

As mentioned above, these schemes are particularly favored by those who have exhausted all other tax-effective investments by maxing out their contributions, so they have only grown in popularity since being introduced.

The main tax relief benefit is easy to remember: when you invest in an EIS/VCT, you get relief on income tax of 30%, so for every £100,000 invested, you could get up to £30,000 back. However, in order to claim these attractive benefits, an EIS must be held for a minimum of 3 years and the VCT a minimum of 5 years. Although this is generally a long-term investment (often used to aid retirement), they are often held much longer.

There are some intricate details, too. For EIS schemes, there is ‘deferral relief’ which allows you to defer CGT payable on profit earned from an investment by reinvesting into an EIS. What is special about this benefit is that while you have to pay CGT on your initial investment from your EIS, you can continuously defer the tax bill by reinvesting your gain indefinitely.

EIS schemes can also be used to reduce your inheritance tax bill. After investing in EIS qualifying shares for a minimum of 2 years, if you still hold the shares upon your death, the investment should be free of inheritance tax liability. Unfortunately, VCTs do not offer the same advantage.

What’s the Difference?

Regarding the EIS, you are buying shares directly in a singular, smaller company, whereas with a VCT, the investment is spread over a variety of listed companies, reducing risk. VCTs can be likened to an index fund, but much smaller and consisting of smaller companies (startups and scaleups, etc.).

Alongside EIS, you also have Seed Enterprise Investment Schemes (SEIS) which are also for smaller unlisted companies but target those in the startup stage, whereas EIS covers ‘scaleups’.

The maximum investment for VCTs is capped at £200,000 per year, whereas with EIS you can invest up to £1 million, which jumps to £2 million if at least £1 million is invested in ‘knowledge-intensive companies’.

Additionally, VCTs may pay out tax-free dividends to investors provided they are growing, but if they are struggling, they may not be able to afford it. Any dividends paid from an EIS are taxable.

Sounds Good, but What Are the Risks?

While the tax benefits might seem good (they are!), it’s important to consider the risks, especially given the unique nature of this investment. These schemes promote investment in smaller, developing businesses which are much more volatile and much more likely to fail, especially compared to anything listed on the main London Stock Exchange.

Credit: Maxim Hopman via Unsplash

An additional risk of investing in these schemes is the lower demand, which in turn makes them harder to sell than your average blue-chip stock. They are considered high risk, and the general consensus is to only allocate a small amount of your portfolio to them.

If you are considering investing in any of these schemes, we recommend you seek professional advice from a financial advisor or similar due to the risk involved.

Last but Not Least, the AIM Market

Launched 25 years ago, the Alternative Investment Market was introduced to help smaller companies grow but couldn’t afford the costs or didn’t meet the requirements to be listed on the LSE. Since being introduced, over 3,998 companies have raised over £130 million in capital.

With a majority of the companies being listed on AIM at the startup stage, they tend to be small and carry the potential of being a high-risk investment.

Tax Benefits of AIM Investing

In 2014, a change in rules was made which allowed investors to include AIM shares in Stocks and Shares ISAs, removing the CGT on disposal and Income Tax which was payable on dividends.

The majority of AIM stocks are qualified for Business Property Relief and exempt from Inheritance Tax if held for 2 or more years, making it a solid consideration for a retirement investment.

Thank you for reading!

This was the first issue of The HENRY Letter. While this is still in the early days, we hope this provided you with some insight. Please feel free to give feedback via the comments or the Reddit group.

Thanks for your continued support,

Joe :)