Investors with a higher appetite for risk and a desire for larger tax efficient investment portfolios have often been limited to Venture Capital Trusts (VCT) for several years. However, changes that were made to the rules governing Enterprise Investment Schemes (EIS) in 2011 gave investors a real choice between two distinctive opportunities for growing capital and realising significant tax benefits.
The income tax relief associated with EISs was increased to 30 percent, and popularity in this form of investment increased significantly shortly afterwards. However, there are still some stark differences between the two product types, so it is prudent to consider all the relevant factors before deciding which fund to invest in.
VCT and EIS
A clear difference between the two types of product is the holding period that qualifies for tax relief. A VCT must be held for a minimum period of five years; however, EIS qualified shares are only required to be held for three – giving investors a short-term option that might appeal to their investment strategy. Despite the shorter holding period, however, the process of claiming tax relief against a VCT is far simpler. A tax certificate arrives in a matter of weeks with a VCT, but investors in an Enterprise Investment Scheme will have to wait until their money has been invested and the EIS qualified companies have commenced trading before tax rebates can be sought. A VCT will also issue just one tax certificate for all investments. You can invest up to £1 million in EISs and carry over unused allowances to the following year, whereas the maximum annual investment into a VCT is £200,000.
Using the assets as a Source of Retirement Income
Anyone considering an investment trust as a source of income for retirement may consider a generalist or Alternative Investment Market VCT. This type of investment not only provides dividend payments, but these payments are also exempt from tax. On the other hand – dividends received from EISs are subject to tax, and they can curtail your income throughout your retirement.
However, there is a trade-off to consider. Although VCT dividends incur no capital gains tax, passing your investment on to your heirs will be subject to inheritance tax. If you have held EIS shares for a minimum of two years, however, bequeathing them will incur no inheritance tax whatsoever.
Selling your Shares
Unlike VCTs, EIS shares are not listed on the stock exchange as public companies. This means that, in theory, getting out of a Venture Capital Trust should be easier, as shares can be sold on the open market. Unfortunately, a VCT’s share price does not always correlate with its performance, so you may be forced to sell your shares at a discount.
Asset managers responsible for EISs will make it clear to investors from the outset that getting a return from the portfolio will not be possible until a trade sale or stock market flotation realises underlying investments. As unquoted EIS shares cannot be sold in a secondary market, they could be looked upon as illiquid assets which require a minimum commitment of three years in order to realise their tax benefits.
Summary and conclusion
Generally speaking, EIS’s will concentrate their investments on start-ups and fledgling companies, which can be a riskier endeavour, but has potential for higher returns. However, their shorter minimum holding period and exemption from inheritance tax are notable advantages. A VCT, on the other hand, is more likely to invest in slightly more established companies with a proven income stream. In addition, dividends and profit from a VCT are exempt from tax.
While both investments are speculative and not without risk, there are options to reduce that risk through investing in products that concentrate their efforts on capital preservation instead of growth. Which option you choose to invest in will depend on your tolerance to risk, your tax priorities and your desire to see long-term growth. Speaking with a financial advisor will help you to ascertain which product best meets your specific requirements.