March 25, 2011 6:18 pm

Enterprise investments become more tax-efficient

Enterprise investment schemes (EISs) are set to overtake venture capital trusts (VCTs) as the tax-efficient investment of choice for top earners hit by higher tax bills and falling pension contributions, following new rules announced in the Budget.

As part of a package of measures to boost investment in growth companies, George Osborne, chancellor, expanded the scope of both schemes – but significantly increased the tax relief and investment limits for EISs.

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From April 2012, investors in EISs and VCTs will be able to get tax breaks on investments into companies with gross assets of up to £15m, as many as 250 full-time employees and annual fundraising targets of as much as £10m.

Under the current rules, the schemes are restricted to smaller companies with gross assets of up to £7m, and fewer than 50 employees, raising no more than £2m a year.

However, while the annual limit on investment in VCTs will remain at £200,000, the amount that can be put into EISs will double from £500,000 a year to £1m from April 2012, and the upfront tax relief will increase to from 20 to 30 per cent from next month to match the relief on VCTs.

EISs will also retain their other tax advantages. These include no capital gains tax (CGT) on any profits if held for three years, deferral of CGT on gains reinvested, offsetting of losses against other gains, and exemption from inheritance tax (IHT) once held for two years.

Analysts and asset managers said these benefits would make EISs one of the most efficient investments for higher and top-rate taxpayers.

“The EIS has got every tax break you can throw at it – it really has the full set,” said Martin Churchill, editor of industry publication Tax Efficient Review.

Jason Hollands of fund manager F&C noted that the upfront relief was already appealing to high earners, who will see their tax bills rise from April 6, and their annual pension contribution limit fall to £50,000.

“With the highest rate of income tax now 50 per cent, interest in schemes that attract income tax relief has grown,” he said.

As a result, some advisers believe the sums invested into EISs will soon surpass annual inflows into VCTs.

At present, private invest-ors put around £400m a year into VCTs via advisers, according to Tax Efficient Review, with £120m-£150m going into EISs. But, by the time all the new rules take effect, EISs are expected to overtake VCTs in terms of annual investment.

“We will see an enormous explosion in EIS offerings,” said Churchill. He forecast a doubling of EIS investment in 2011-12, and a further increase in 2012-13.

Andrew Clark, of advisers Bestinvest, agreed: “Do I think there will be more inflows into EIS? Yes, as you get loss relief if it goes wrong.”

However, some advisers warned that EIS investments will remain riskier than VCTs – and may attract investors for the wrong reasons.

“There is a risk that increasing initial tax relief on EISs will attract those for whom they are not suitable investments,” said Patrick Connolly of AWD Chase de Vere. “They shouldn’t ever be mass market products.”

Churchill conceded that EISs still have several downsides: “They are complex products, transparency is not great, and you are left holding unquoted investments with no liquidity.”

VCTs, which are quoted on the stock exchange and can be sold at any time, are expected to remain attractive to more risk-averse venture capital investors.

But schemes investing in companies backed by property assets and steady revenues may not be available much longer, as the Treasury is “refocusing” the rules to ensure schemes target “genuine” risk capital investments.

“VCTs and EISs that have not invested in British-based innovation are likely to cease to exist,” said Julian Hickman of Longbow Capital.

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