Risky, but the tax breaks are unbeatable


The following article was published in The Times on Saturday 30th March 2013 by David Budworth.

“Investments that enable you to chop your tax bill backing colourful businesses involved in feature film development, online gaming and solar power sound like the sort of schemes that ministers have been doing their best to shut  down. Just this week, the actress Aoife Madden and four others were jailed for fraud after engineering a sophisticated scam to cheat the taxman centred around a fake British gangster flick, A Landscape of Lies.

In fact, the schemes in question come with the full backing of the Government. The Chancellor even announced in the Budget that some of the most generous tax reliefs available on such investments will be extended for another year.

The tax breaks are there to encourage investors to back small and growing unquoted enterprises, the businesses that the Government hopes will help to re-spark growth. Backing fledgling businesses is high-risk, so the  Government offers a number of attractive reliefs in compensation for the risk that you are taking.

The perks come in several forms, and there is still time to make use of them before the end of the tax year.

Venture capital trusts

For novice investors these funds listed on the London Stock Exchange are the friendliest option. They allow you to put up to £200,000 a year into a  collection of small unquoted companies. In return, there is a 30 per cent income tax refund on the money you invest, provided you have paid at least that much in tax in the year you invest. So an investment of £10,000 would effectively cost you £7,000 after tax relief.

Dividends paid by the trust are free from income tax and there is no tax on capital gains you make when you sell your investment. You have to hold the shares for at least five years to qualify for the reliefs.

Should you invest?

VCTs are high-risk and their performance since they were introduced 18 years ago has been mixed. But some have managed to produce good returns over the long term and are paying out healthy tax-free dividends to investors.

Mike Horseman, of Cockburn Lucas, the independent financial advisers, says: “In a low-return world the ability to take a tax-free income sits quite well as part of a retirement strategy. Some of the companies that the schemes  invest in will go bust but that should be compensated by most VCTs holding  20 to 25 companies.” A lack of buyers for those who want to sell shares has been an issue for VCT investors. But some now provide guaranteed buy-back schemes, usually at a 5 or 10 per cent discount to their net asset value.

Are the tax reliefs safe?

It seems so, though the small print of the Budget contained a potential threat. Some managers offer an “enhanced buy-back facility” where you sell your shares and get new ones in the same VCT, enabling you to claim another  30 per cent income tax relief. In the Budget, George Osborne said he was concerned “that VCTs offering enhanced buy-backs are not operating within the spirit of the legislation”.

Enterprise investment schemes

EISs are a step up the risk scale. Some invest only in a single company, though others are funds with typically around ten holdings. Unlike VCTs, they are not permitted to offer a “planned exit”, and because there is no ready market for EIS shares you must be prepared to tie up your money for an indefinite period.

There is upfront tax relief of 30 per cent on your investment. So anyone  putting in the maximum amount of £1 million in a financial year would obtain £300,000 in tax relief.

Provided the investment is held for the required three years there is no capital gains tax to pay when the EIS is eventually sold. There is likewise no inheritance tax to pay on EIS holdings once they have been held for two years. However, dividend payments are taxable, so most EIS companies do not pay them. If capital gains on another asset are realised tax can be deferred if they are reinvested in an EIS, and there are no limits to the size of gain that can be deferred, or “rolled over”, in this way. You do have to pay tax on this eventually but only when you sell.

What is the seed EIS?

A micro version of the main EIS scheme focused on even smaller companies. To reflect the extra risk, investors can obtain upfront tax relief of 50 per  cent on annual investments of up to £100,000. Any capital gains rolled over into a Seed EIS is CGT-free, even when the reinvested gain is eventually crystallised through a sale.

Originally these tax breaks were only going to apply in this tax year. However, in the Budget the Chancellor extended the relief for another 12 months with a slight tweak. From April 6 relief will be available on 50 per cent of the reinvested gain only and not 100 per cent as now.

What should you buy?

There are two main types of VCT: generalists that invest across a variety of sectors, and planned-exit VCTs that aim to wind up as soon as possible after five years, though there are no guarantees.

Mr Horseman prefers generalist funds from Unicorn, Mobeus, and the “crème de la crème” Baronsmead. However, these popular VCT managers tend to sell out fast and only Mobeus has a fund that is still open for new money. Martin Churchill, the editor of www.taxefficientreview.com, likes ProVen Growth & Income and the offer linking three Mobeus VCTs. For a planned exit he chooses Foresight Solar VCT C Share and Puma VCT 9.

On EISs, he says: “This year there has been an explosion of new EIS offers — 55 — and they won’t all successfully raise money.

“A lot of the attention is on the renewables, which I would expect to give a dependable though not a fantastic return. The big risk is who will buy the assets in the future and at what price.”

However, he is happy to recommend Foresight’s Solar EIS fund and Oxford Capital Infrastructure, which is also expected to have a renewable energy bent.”

Case study: ‘The real attractions are the tax advantages’

Ken Warburton, a retired radio presenter and businessman, has invested in a  dozen VCTs.  

Ken, 69, pictured with his wife, Sue, has built up a broad portfolio of  holdings over the years and has shares in trusts run by managers including  Baronsmead, Foresight and Mobeus. Ken, from Derby, says: “I would like to  say that part of me likes to support start-up businesses but the real  attractions are the tax advantages.”

A keen motorcyclist and amateur pilot, he says that he has benefited nicely  from the dividends he gets. “Baronsmead has been very good. The dividends I  have received are about the same as the amount I invested,” he says.

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