So, you're looking to invest in the next game-changing SME, benefit from tax savings and support the economy. But what's the best way to do it?
Two popular options include the Enterprise Investment Scheme (EIS) and venture capital trusts (VCTs). However, one might be more suitable than the other, depending on individual circumstances.
EIS vs VCT – What's the difference?
EIS is a government scheme, which provides a tax-efficient way to invest in unlisted, small companies, with growth potential. This investment can be invaluable for giving them the leg up they need, to take their business to the next level. You can invest up to £1m, rising to £2m, if the investment is in ‘knowledge-intensive' companies, such as those in the life-sciences sector. EIS investors must be UK taxpayers.
The companies funded also need to meet certain criteria – they must have fewer than 250 employees, have been trading for under seven years (10 for those in the knowledge-intensive category) and their gross assets must be less than £15m.
Moving on to VCTs, these are HMRC-approved companies which trade their shares on the stock exchange and are run by a fund manager. Similar to EIS, VCTs invest in unlisted, small businesses, to help them grow. The way they work is by pooling investments, enabling investors to spread their risk over a number of small companies. Investors, who must be 18 or over, can buy shares at the launch of a trust, or from other investors at a later stage. The annual maximum investment into a VCT is currently £200,000 – somewhat less than EIS, but you can invest in both in the same year.
Both EIS and VCTs are well established (launched in 1994 and 1995 respectively), successful and have attracted a substantial level of investment. To date, more than £20bn has been raised through EIS, funding close to 30,000 companies. Around £7bn has been invested in VCTs so far, and VCT-backed companies have created more than 27,000 jobs
Tax benefits, rules, and eligibility
EIS and VCTs have attractive tax benefits, but different rules and eligibility criteria apply, so it's worth comparing them carefully.
Income tax relief
Both EIS and VCTs allow income-tax relief of 30% on newly issued shares, but with an EIS investment it may be possible to carry back the relief to the previous tax year.
The minimum holding period for an EIS investment is three years, but you have to wait a little longer to be eligible for your tax relief with a VCT (five years).
EIS investments are typically made into unlisted companies, although some EIS-eligible companies are listed on AIM. As such, EIS investment are generally considered an illiquid asset. Investors should expect to hold their investment until the company is sold or lists on a stock exchange. It is possible to sell VCT shares on the open stock market, but if the five year holding period is not met investors will be required to pay back any tax relief that has been claimed.
EIS and VCT also vary when it comes to dividends; if you have a VCT, they're tax free, but EIS dividends are taxable.
Capital gains tax
Both EIS and VCTs are exempt from CGT on sale of shares – in the case of EIS investments, the exemption applies after three years. There is no holding period for VCTs.
From an inheritance-tax standpoint, EIS investments qualify for business relief for IHT, so they are free of IHT after the shares have been held for two years and if held at death. This benefit doesn't attach to VCTs though.
EIS investments may qualify for loss relief, so if you sell EIS company shares at a loss, you could potentialy offset this against capital gains or taxable income.
One particular rule to be aware of with EIS investments is that if you're a paid director of the company you've invested in, at the time the shares were issued, you can't claim tax relief (unless your payment is a ‘permitted' payment). There are also rules around investing in a company you or your associates (which includes family members) are connected to. These are also worth looking into in advance.
Claiming tax relief
It's fair to say that, historically, claiming EIS tax relief has been a little admin heavy. It involves form-filling and can require you to provide a considerable level of detail. However, SyndicateRoom's Access EIS fund aims to reduce the administrative burden of the self-assesment process by providing investors with digital EIS certificates which can be easily attached to an HMRC submission.
In comparison to more the traditional EIS funds or direct investments, claiming tax relief on VCTs is quite straightforward. The tax relief is delivered in the form of a tax credit for you to set against your overall income-tax liability. You claim the relief through your self-assessment tax return for the tax year in which the shares were issued. And you don't even have to wait until you send in your tax return; you can just ask HMRC to adjust your tax code or you can ask for a tax refund.
Summing up, both EIS and VCTs offer the opportunity for eligible investors to benefit from generous tax reliefs, support exciting new businesses, and help boost the UK's economy. You just have the choose the right vehicle for your financial circumstances.
The information on this page does not constitute financial advice and is provided on an information basis only, based on research using the following sources:
- HMRC Tax relief guide for using venture capital schemes
- HMRC self-assessment helpsheet
- EIS Association website
- HMRC policy paper on EIS and knowledge-intensive companies