Given the unprecedented fiscal measures taken to mitigate the economic damage caused by Covid-19, the UK government cannot ignore the possibility of increasing the rates of certain taxes. And with the Office of Tax Simplification’s review of capital gains tax (CGT) already underway, this is one area that could well be set for reform.
Tax-conscious investors – in particular those looking to build their pension pot securely or sell their businesses in the next few years – may be feeling uneasy about what lies ahead. Fortunately, there are ways in which advisers can solve this problem and alleviate their clients’ concerns.
There are a number of investment schemes that are less likely to be targeted by potential reforms on the basis they are specifically designed to boost investment into early-stage UK businesses in return for providing investors with generous tax breaks. These include the Enterprise Investment Scheme (EIS) and venture capital trust (VCT) propositions.
Tax benefits
Investing in EIS and VCT products can be especially attractive for investors at various stages of the pension-planning process – and VCTs have particular value for any investors close to or in retirement.
A key feature of a VCT is its ability to pay out tax-free dividends, offering investors in pension drawdown a crucial alternative income stream. Furthermore, VCTs are main market-listed funds and can be sold – after being held for five years – with any profits on their disposal being CGT-free.
VCTs are an attractive investment for a range of investors, however – and particularly high-net-worth individuals constrained by the limits on their pension contributions. Another key feature of a VCT is the 30% upfront income tax relief, which is available on investments of up to £200,000 per tax year.
Unlike VCTs, the EIS tends to be more useful for investors who would benefit from initial income tax relief, but who do not need an income stream. EIS holdings rarely provide dividends as these are taxable and are not listed – as such, they tend to be better for investors comfortable with long-term investment horizons.
EIS offers income tax relief at 30% on investments of up to £1m a year – five times the VCT allowance – and this can be taken in the tax year the investment is made, or carried back to the previous year, making them particularly attractive for high-net-worth individuals.
In addition, EIS investments also have some use in late-stage retirement planning too as, among other tax benefits, investments qualify for 100% IHT relief after only two years – something VCTs do not offer.
With CGT likely to be ‘levelled up’ to some degree in the coming months, investing in EIS vehicles represents an attractive option for entrepreneurs looking to sell their businesses after the potential changes, as EIS schemes grant investors the ability to defer CGT liability. Furthermore, as is the case with VCTs, any profits made on investments are CGT-free.
Post-pandemic opportunities
Adding to the extensive tax benefits offered by VCT and EIS products, both schemes provide investors with opportunities to seek positive real yields while also boosting UK businesses. Over the coming months, there should be more opportunities for EIS and VCT managers to invest in high-quality, better-capitalised companies with lower valuations due to the crisis.
As was observed in the previous crisis of 2008/09, times of great change create significant opportunities for entrepreneurs to innovate and create thriving businesses in response to the challenges that emerge. Many companies born during the global financial crisis, such as Uber and Slack, went on to become so-called unicorns – valued at $1bn-plus – and it is likely more will arise over the coming year.
Reinforcing this, the coronavirus crisis has lowered key costs for start-ups, such as rent and marketing, and also increased business owners’ access to the skilled talent they need to grow their businesses – again, likely at a lower cost. This means growth companies will be able to do more with less and therefore grow much more quickly.
Helped by volatility in the stockmarkets, this lower-cost business environment has translated to the valuation level in the venture funding market, making VCTs and EIS even more attractive investment prospects.
Belinda Thomas is a partner and head of sales and investor relations for Triple Point
