Tax boost for alternative saving vehicles

With annual allowances being reduced to £50,000 from April 6, some individuals may consider using other investment vehicles, such as venture capital trusts (VCTs) or Enterprise Investment Schemes (EISs) to top up their retirement income.

Chancellor George Osborne’s budget, announced on March 23, arguably makes VCTs and EISs much more attractive than they were previously.

Following the recommendations of the Office of Tax Simplification, which called for investor and investee conditions to be simplified to encourage investment, Osborne announced a rise in income tax relief to 30% for VCTs and EISs.

The government will also increase the annual EIS investment limit for individuals to £1m, raise the qualifying size of companies VCTs and EISs can invest in to 250 employees. The annual investment limit for qualifying companies is also due to rise to £10m.

There are also further plans to consult on options to provide simplification of the EIS rules by removing some restrictions on qualifying shares and types of investor.

VCTs and EISs provide investors with options to defer capital gains tax (CGT) and boost income tax relief, but unlike other maximum investment plans, you’re only required to hold them for three to five years.

EISs were historically used by people who have capital gains they are looking to shelter. VCTs were preferred as retirement topup vehicles due to the increased corporate governance available.

The big downside with these vehicles is they have to be invested in small companies with no market share in them, and when you come to sell them, if there’s no market available you could be forced to hold on to them.

The annual management charge for these structures is also considerably higher than other wrappers at typically 2.5%.

Patrick Reeve, managing partner at Albion Ventures, suggested VCTs were more attractive as a pension top-up, due to their increased corporate governance and the broader investment portfolios available to investors.

“EIS shares aren’t tradeable and there isn’t an independent board of trustees looking after the shareholders’ interests, so there’s less corporate governance available,” he said.

“VCTs are more for wealthy retail investors, EISs, I’d suggest are more for high net worth individuals.”

Reeve added that most VCTs had performed at least as well as the FTSE AllShare that none had gone bust and lost all of their investors’ money.

When investing, the initial investment will enjoy 30% income tax relief, and if individuals choose to take their dividends in share form and reinvest them in VCTs during the accumulation stage, these too will be subject to 30% income tax relief.

At retirement, investors simply switch to start receiving dividends in cash form instead, entirely free from tax.

Returns from VCTs vary, depending on how risky the prospect is. Reeve explained: “Say the VCT is investing the development of a cinema; that’s fairly predictable so you could expect a 15% per annum return. For something more risky, such as a start up pharmaceutical company, you’d be looking at more like 50% per annum.”

However, Jonathan Gain, chief executive of Stellar Asset Management, argued EISs have never been more attractive as the budget’s amendments had brought the two vehicles closer than ever. “In terms of what they can invest in, VCTs and EISs are identical now,” he said.

“EISs do have some advantages; with VCTs you are required to hold them for five years, unless you can find a buyer on the market or get your manager to buy the shares back. If you do, managers’ typically take a 10% discount off the net asset value, the market can be as high as 20-30%.”

EISs also benefit from being exempt from inheritance tax after three years of being invested, a benefit investors find so attractive many become serial EIS investors, rolling one set of investments into the next.