Relief is out there – if you look for it

Higher earners facing an increase in their income tax and national insurance from April, and a reduction in their pension contributions, have been given an opportunity to gain more tax relief by investing in UK enterprise.

Although the chancellor announced another £630 increase in the personal tax allowance, to £8,105 in April 2012, on top of the £1,000 increase to £7,475 next month – and said the measures would see “no more people pulled into the higher rate tax band” the freezing of the higher-rate threshold from April this year will mean a tax rise for most people earning more than £45,000. Higher earners face a bigger tax increase, as the higher personal allowances are still tapered down to zero once they are earning more than £115,000.

At the same time, new pension rules – also coming into force from April – will cap the level of contributions that can earn tax relief at £50,000, rather than the previous maximum of £255,000 for those earning up to £130,000.

However, wealthier private investors are now being given the chance to offset the loss of these tax breaks by taking advantage of generous new tax incentives for investing in small UK companies.

As part of a package of Budget measures to stimulate economic growth, the chancellor has announced a widening of scope of Enterprise Investment Schemes (EISs) and Venture Capital Trusts (VCTs), allowing investors to put up to £1m into these tax-efficient vehicles at a cost of 70p in the £1.

As of next month, upfront income tax relief for investments into EISs will rise from 20 per cent to 30 per cent – bringing EISs into line with the relief currently available on contributions into VCTs. But from April 2012, the amount that any individual can invest in the EIS will double from £500,000 to £1m a year, and the size of company that qualifies for investment under either scheme will be increased. At present, EIS and VCT investments are limited to companies with gross assets of no more than £7m and fewer than 50 employees. In the 2012-13 tax year, companies with gross assets of £15m, up to 250 employees, and total fundraisings of £10m a year will be eligible investments.

In their current form, EISs also provide a range of additional tax reliefs, including no capital gains tax (CGT) on profits if held for three years, deferral of CGT on gains reinvested, offsetting of any losses against other gains, and exemption from inheritance tax (IHT) once held for two years. In the 2008-09 tax year, these incentives attracted £503m from private investors and provided nearly 2,000 businesses with access to development capital.

Now, investment managers and advisers forecast that EISs will become significantly more attractive to private investors, as the tax relief on them increases while the risk profile of companies becomes more varied.

“The combination of increased tax relief and access to EIS for larger businesses will attract far more capital to drive growth,” said David Mott, investment director, of Oxford Capital Partners, the EIS manager. “With the government effectively stumping up a third of the cost of investing – and giving loss relief if anything goes wrong, the opportunity to invest in a well-diversified portfolio of EIS businesses has never been more attractive.” Jonathan Gain, chief executive of Stellar Asset Management, described the EIS tax breaks as “fantastic”. He said: “They are now much, much more attractive to investors. They can invest in a wider universe of companies.”

Private client advisers said the choice open to private investors would quickly increase. “Both EIS and VCTs will benefit from a change in the rules determining which companies qualify for investment as these become less restrictive and will, in turn, increase the universe of investment opportunities significantly,” said Adrian Lowcock of Bestinvest, the independent financial adviser. Patrick Stevens, tax partner at Ernst & Young, acknowledged that this would push EIS investments “in the right direction” on the risk spectrum, as larger and better established companies became eligible.

However, some advisers also expressed concern that the tax breaks could encourage too many private investors to invest without considering the risks.

“While important, tax considerations shouldn’t determine investment strategy,” warned Patrick Connolly of AWD Chase de Vere, the independent advice firm. “It must be remembered that EISs and VCTs are only usually suitable for wealthier clients with diversified investment portfolios who are willing to invest long-term and accept higher levels of risk. They shouldn’t ever be mass market products.”

VCTs will enjoy the same relaxation of the rules on qualifying companies, but will retain their annual investments limit of £200,000 – and face further possible restrictions. An ongoing review of their rules will aim to “ensure they are targeted at genuine risk capital investments” – suggesting the lower-risk asset-backed, or “planned exit” schemes currently being marketed, may not be permitted in future.

In addition, large-scale solar energy projects that aim to take advantage of the government’s electricity feed-in-tariff have been added to the list of excluded activities for VCT investment.

However, the tax breaks attached to commercial property investment in Enterprise Zones will not be continued – even though the chancellor announced the designation of 21 new zones in his speech. Under the old Enterprise Zone rules, syndicates of investors could put down 30 per cent of the cost of new building, borrow 70 per cent in non-recourse bank loans, and gain tax relief on between 90 and 98 per cent on the total amount invested. But the new Enterprise Zones will offer only enhanced capital allowances for investment in plant and machinery. “As far as we can see, there is not going to be any recurrence of Enterprise Zone syndicates of individuals to invest in property,” said Mr Stevens.