What does this show?
This chart illustrates the popularity, as measured by total amounts raised each tax year, of two government-approved tax breaks — the enterprise investment scheme and venture capital trusts — that encourage investment in smaller UK companies.
Since their launch, in 1993 and 1995 respectively, more than £16bn of qualifying investments have been made.
How do the EIS and VCTs differ?
Both schemes attract significant tax breaks for investors, offsetting the inherently higher risks associated with investing in small companies.
Income tax relief up to 30 per cent of the cost of shares is available on initial investments and any returns are exempt from capital gains tax (CGT).
There are important differences though. Unlike EIS holdings, VCT shares are listed — offering a degree of liquidity — and investors can be paid tax-free dividends. They have to be held for five years to qualify for tax reliefs, however, whereas EIS investments need only be held for three.
Why has more money been invested via EIS?
Importantly, taxpayers can allocate more to EIS-qualifying investments in any given tax year than to VCTs. While annual VCT funding limits stand at £200,000, individuals can invest up to £1m in EIS projects — having doubled from £500,000 in 2012-13.
The tax breaks are arguably also more generous. After two years, EIS shares qualify for business property relief, meaning they are exempt from inheritance tax. For taxpayers with existing CGT liabilities, EIS investments allow deferral of payment for up to three years.
Why have investment levels been so volatile?
Although investments are to some extent linked to the economic cycle — EIS inflows peaked in 2000-01, at the height of the dotcom boom — changes to the tax regime have played a major role.
The near-doubling of EIS investments in 2011-12, for example, followed an increase in the income tax relief awarded from 20 to 30 per cent.
VCT investment levels have been acutely responsive to tax changes. In 2004-05, when income tax relief doubled to 40 per cent, VCT inflows shot up sevenfold. Having peaked at £780m in 2005-06, investments fell by two-thirds the following year as the relief was lowered to 30 per cent.
What else is behind the recent increase?
Combined VCT and EIS investments were close to record levels in 2012-13, and in 2013-14 — for which official EIS figures are not yet available — VCT inflows reached an eight-year high.
The growing popularity of venture capital schemes has been widely attributed, at least in part, to the historically low returns offered by more conventional lower risk investments, such as bonds and shares. Well-established VCT managers offer relatively high dividends attractive to income investors.
Reductions to annual and lifetime pensions allowances have also limited the amount that taxpayers can save tax-free into their pensions. With savings into Isas also restricted, VCTs and EIS investments are widely seen to offer two of the few government endorsed means for higher earners to invest tax efficiently.
What about renewables?
The introduction in 2010 of the “feed-in-tariff” scheme, where producers are paid a fixed above-market price for generating renewable electricity, resulted in large investment into the sector via EIS.
While these trades were excluded in 2012, EIS money continued to flow into solar projects that benefited from Renewable Obligation Certificates until they were disqualified from the schemes last summer.
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