In the first of a new series of tax-planning articles for Professional Adviser, Jack Rose puts the case for tax-advantaged investments such as enterprise investment schemes and venture capital trusts
Enterprise investment schemes (EISs), venture capital trusts (VCTs) and business relief products are by no means new in the market place. Business relief – which until recently was known as Business Property Relief or ‘BPR’ – was first introduced in the 1976 Finance Act. For their part, EISs replaced the old Business Expansion Schemes in 1994 while VCTs were introduced in 1995.
While figures for assets raised in business relief schemes are hard to come by, the last tax year saw more than £2bn raised across EISs and VCTs. According to HMRC and AIC data respectively, since inception, EISs have attracted more than £14bn and VCTs more than £5.6bn into the UK small and medium-sized enterprise (SME) sector.
Despite all three structures having an established market with a 20-year-plus track record – and even though recent changes in both government legislation and pension rules have made the investment case even more compelling – many financial advisers still do not include them in their tax-planning arsenal.
The introduction of the so-called ‘GAARs’ (general anti-abuse rules) and ‘DOTAS’ (disclosures of tax avoidance schemes) regimes has been described as the ‘kiss of death’ for aggressive tax avoidance schemes – as demonstrated by a number of high-profile cases in the tabloids over recent years.
This, in combination with the Retail Distribution Review’s ‘whole of market’ legislation, is now leading many advisers to look towards government-approved EISs, VCTs and business relief products for their tax-planning needs.
Why Does The Government Give Tax Breaks?
EISs, VCTs and business relief each offer a number of distinct tax incentives allowing them to fulfil different requirements in an investor’s portfolio. VCTs, for example, offer tax-free dividends, meaning they may be more suitable to an investor looking to maximise income.
A golden rule of investment, however, is that you do not get anything for free. The government’s generous tax incentives associated with these vehicles are designed to offset the risk of investing in smaller, unquoted or AIM-listed companies. Furthermore, investments must meet certain criteria – both at the investor level (such as minimum holding periods to qualify) and the underlying investee company level (such as a maximum revenue size or number of staff).
The increased risk nature of these strategies means they are not suitable for everybody. For the right investor, though, they can form an important and complementary part of their overall portfolio.
The Catalysts Behind A Growing Market
Aside from the changes in government legislation outlined above, there are a number of other factors driving the growth in the market.
First, changes in pension rules – particularly, restricting annual contributions for additional-rate taxpayers and reducing lifetime contributions to £1m – have restricted the tax-planning options for high earners, pushing advisers towards alternative and complimentary pension planning investments, and VCTs in particular.
The tax-free dividends offered by VCTs, alongside no capital gains tax on gains, make them an attractive alternative source of tax-free income, which can complement a traditional pension portfolio.
Second, the dynamics for SME asset-raising through EIS and VCT structures continue to be favourable. The best part of a decade on from the 2008 financial crisis, the market for SME funding remains well below pre-2008 levels. With traditional sources of funding difficult to secure, demand for funding via EIS and VCTs far outstretches supply. This has created a positive environment for EIS and VCT managers with a number of potential deals in which to deploy new cash.
Finally, inheritance tax (IHT) continues to be an ever-growing problem for advisers and their clients, exacerbated by rising property prices. The result is that a record number of people’s estates are due to fall outside the current nil-rate band of £325,000.
Even with the addition of the main residence nil-rate band that is due to kick in from next April, the Office for Budget Responsibility forecasts IHT revenues are expected to rise by nearly 11% a year for the next four years – and to the highest level as a share of the UK economy since the 1970s. Last year, HMRC took a record £4.6bn from IHT receipts and this is forecast to rise to almost £5bn for this current tax year.
With the nil-rate band remaining at its current level until 2020/21, business relief strategies offer a simple way for investors to reduce their IHT liabilities after just two years. Furthermore, such strategies offer a flexibility, control and timescale that traditional estate planning options, such as gifting or trusts, often cannot.
There are a diverse range of EIS, VCT and business relief products and managers available across multiple investment strategies and asset classes. The markets for each of these tax-efficient structures is long-established and provides billions of pounds in vital investment each year into the UK SME sector.
Each structure provides a different range of tax-planning benefits, which can be tailored to the client’s investment objective. These structures can form a valuable part of an adviser’s tax-planning arsenal – and demand is only set to grow.
In future articles, we will examine EIS, VCTs and business relief strategies in further detail, including their key features, how best to use them in a client’s portfolio and what to look for in a good manager.
Jack Rose is head of tax products at LGBR Capital
Click here to see the whole article
For more information on LGBR Capitals range of tax products please click here or call 020 3195 7100.