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3 interesting pros and cons of investing in VCTs and the EIS

Investing in VCTs and the EIS may offer some tax benefits but there are some potential drawbacks. Learn about three interesting pros and cons of these investment vehicles.

27/06/2023
Benchmark customer focused

Tax efficiency may be a key concern when choosing investments, which is why you might want to consider the benefits of Venture Capital Trusts (VCTs) and the Enterprise Investment Scheme (EIS).

These government-backed vehicles aim to encourage investment in companies looking to grow, and they offer several potential benefits. However, there may be some confusion about how these schemes work and what the pitfalls could be.

Read on to find out about the differences between VCTs and the EIS, as well as three pros and three cons of each.

VCTs and the EIS encourage investors to back fledgling businesses

VCTs and the EIS both encourage investors to back small businesses with high growth potential, but there are some key differences between them.

A VCT is a private investment entity, managed by a fund manager and listed on stock exchanges. You buy shares in the VCT and the fund manager then invests the pool of capital in qualifying companies on your behalf. You can invest up to £200,000 in VCTs each tax year.

The EIS, on the other hand is an incentive scheme that offers tax benefits to investors that back qualifying companies. You directly buy shares in high-growth companies that meet the criteria, and you can invest up to £1 million in this way each tax year.

The EIS also has different criteria for Knowledge Intensive Companies (KICs). These are businesses that spend heavily on research and development, and you can invest an additional £1 million in these companies each tax year.

VCTs and the EIS both offer some tax benefits to encourage investors to back these businesses and inspire growth. However, it is important to consider the pros and cons of these investment vehicles, as well as your own goals, when deciding whether they are the right option for you.

3 pros of investing in VCTs and the EIS

Tax relief

Tax relief is one of the key benefits of investing in VCTs and the EIS. When you buy shares in EIS-qualifying companies, you can claim Income Tax relief on up to 30% of the value of your investment.

For example, if you invested £100,000, you could potentially claim up to £30,000 in Income Tax relief. You can invest up to £1 million in standard EIS companies and receive tax relief in this way, meaning you could claim up to £300,000 of relief in a single tax year.

Additionally, you can claim 30% relief on a further £1 million if you invest in KICs, taking the total potential tax relief on offer up to £600,000.

Similarly, you can benefit from the same 30% Income Tax relief on VCT investments. With these vehicles, you can invest and receive tax relief on up to £200,000 each tax year, so the maximum relief you can claim is up to £60,000.

So, you may want to consider investing VCTs and the EIS if you have a large Income Tax bill that you’d like to mitigate.

Tax efficiency

The growth of new businesses is essential for a healthy economy, which is why the government offers some tax breaks when you invest in VCTs and the EIS. For example:

  • Investments in VCTs and the EIS may be free from Capital Gains Tax (CGT) on any growth when you come to sell them. You must hold an EIS investment for three years and a VCT investment for five years before you can benefit from this tax efficiency.
  • You will not pay tax on any dividends from your investments. This is particularly beneficial since the tax-free Dividend Allowance halved to £1,000 on 6 April 2023, and the government plans to reduce it again to £500 in April 2024.
  • EIS investments qualify for Business Relief, which means they can be left to beneficiaries without Inheritance Tax (IHT), provided you have owned the shares for at least two years prior to your death.
  • You may also be able to defer CGT from selling another asset if you reinvest EIS gains in other EIS-qualifying shares. Specific rules apply in this case so you may want to seek advice before trying to defer CGT in this way.

These incentives potentially make VCTs and EIS investments a valuable asset in your portfolio. However, you must hold VCTs for five years, and EIS investments for three years to benefit from these tax incentives.

Invest in businesses with big potential

The businesses that you invest in through VCTs and the EIS are often relatively new, high-growth companies. While this does bring some additional risk and there is no guarantee that your investments will grow, it does mean that you can invest in businesses with big potential for future growth.

Indeed, businesses like Gousto, SimplyCook, Cicero, and Bloom & Wild are just some examples of now-established companies that benefited from investment through VCTs and the EIS.

If you invest early, it may be cheaper than investing once the businesses have already flourished. So, you may have the opportunity to get in on the ground floor and benefit from significant returns in the future.

3 cons of investing in VCTs and the EIS

You’re investing in high-risk businesses

Although some businesses will find success, many may not. That’s because new businesses trying to establish themselves could be more likely to fail, so VCTs and the EIS can be a very high-risk investment.

You’ll need to be comfortable seeing your shares fluctuate more in value than other investments, and the businesses could even fail entirely. That’s why you may want to consider your attitude to risk before investing and if you are averse to high-risk investments, it may be a good idea to consider alternative options.

Fortunately, you can claim “loss relief” on EIS investments if the company fails. This is available at your marginal rate of Income Tax.

Tax relief is limited and subject to change

The tax relief may be one of the main reasons you are considering investing in VCTs and the EIS, but it is important to note that it is limited and may be subject to change.

There are specific criteria you must meet before you can benefit from tax relief, such as holding shares for a certain period of time, for example. So, they may not be the best option for short-term investments.

The total tax relief you can claim is also limited by the Income Tax you pay. For example, if you paid £30,000 in Income Tax and invested the maximum £200,000 in VCTs, you would still only receive relief on £30,000, not £60,000.

Additionally, if the business grows rapidly, it may lose EIS qualification and you can lose the tax benefits altogether.

Investments may be difficult to sell

You may also want to consider that selling VCT and EIS investments can be a challenge. That’s because the secondary market for VCTs is small, as you do not get the tax relief on second-hand shares, though you still get tax-free growth and dividends.

Similarly, you cannot sell EIS shares on the stock market and it can take time to liquidise the assets. So, they may not be the best option for short-term investments, especially if you are likely to need access to the capital in the near future.

Get in touch

If you are considering investing in VCTs and the EIS, we can help you work out whether they are the right option and align with your wider goals. Please visit our contact page or speak to your adviser.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCT) are higher-risk investments. They are typically suitable for UK-resident taxpayers who are able to tolerate increased levels of risk and are looking to invest for five years or more. Historical or current yields should not be considered a reliable indicator of future returns as they cannot be guaranteed.

Share values and income generated by the investments could go down as well as up, and you may get back less than you originally invested. These investments are highly illiquid, which means investors could find it difficult to, or be unable to, realise their shares at a value that’s close to the value of the underlying assets.

Important information

The views and opinions contained herein are those of Benchmark Financial Planning. They do not necessarily represent views expressed or reflected in other Benchmark Financial Planning communications, strategies or funds and are subject to change. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable, but Benchmark Financial Planning does not warrant its completeness or accuracy. The data has been sourced by Benchmark Financial Planning and should be independently verified before further publication or use. No responsibility can be accepted for error of fact or opinion. Benchmark Financial Planning is not responsible for the accuracy of the information contained within linked sites. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Past Performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.

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Benchmark Financial Planning is an Appointed Representative of Best Practice IFA Group Limited which is authorised and regulated by the Financial Conduct Authority, the registration number is 223112. Registered office: Broadlands Business Campus, Langhurst Wood Road, Horsham, West Sussex, RH12 4QP. Registered in England and Wales No 07572431.

The Financial Ombudsman Service is available to sort out individual complaints that clients and financial services businesses aren't able to resolve themselves. To contact the Financial Ombudsman Service, please visit www.financial-ombudsman.org.uk

The guidance and/or advice contained within this website are subject to the UK regulatory regime and are therefore targeted at consumers based in the UK.