If you’re an investor looking to diversify your portfolio and maximise tax efficiency, you could consider more complex investments such as an Enterprise Investment Scheme (EIS), Venture Capital Trust (VCT) or shares in Alternative Investment Market (AIM) listed companies, providing you are comfortable holding high-risk investments.
EIS vs VCTs explained
Enterprise Investment Schemes and Venture Capital Trusts are investments made into small, unquoted trading companies which are trying to raise capital in their early stages of development.
The rationale behind both EIS and VCT schemes is that they benefit the economy by promoting innovation amongst the small higher-risk business community which in turn drives productivity, creates jobs and boosts economic growth.
EIS and VCT schemes are appealing to investors who are typically seeking greater diversity across their portfolio as the investments held have a low correlation to more mainstream holdings in pensions and Individual Savings Accounts (ISAs).
What tax benefits do these schemes offer?
Since their launch in the 1990s, EIS and VCT schemes have become increasingly popular, in large part due to the tax benefits they enjoy. Schemes such as these have been particularly important to investors who may be struggling to find ways to invest tax-efficiently, for example those who are close to breaching pension allowances, but who still want to save for retirement in a tax-efficient way.
There are a number of generous tax breaks. For example, when you invest in an EIS or a VCT, you get income tax relief of 30%: invest £100,000 and you could get up to £30,000 back. In order to qualify for these benefits an EIS investment must be held for at least three years and a VCT for five years, but investors would normally expect to hold the investments for longer.
For EIS schemes there is also ‘deferral relief’ which effectively allows you to defer capital gains tax payable on profit earned from an investment by reinvesting it in an EIS. So you only have to pay the CGT due on your initial investment once you exit from your EIS, but you could carry on deferring the tax bill by reinvesting your gain indefinitely.
There are also ways of using an EIS to minimise your inheritance tax bill. After two years from when you buy the EIS-qualifying shares, as long as you still hold the shares on death, your investment should be free of inheritance tax liability. There is no inheritance tax advantage with VCTs however, as when you invest you acquire shares in the trust, rather than in the underlying companies.
How do EIS and VCT schemes differ?
In the case of an EIS, investors typically purchase shares directly in firms, while VCTs are listed companies and follow a similar approach to that of investment trusts, allowing investors to spread the investment risk over a number of companies by subscribing for shares in the VCT itself.
For the 2023-24 tax year, the following limits apply:
In the case of an EIS, investors typically purchase shares directly in firms, while VCTs are listed companies and follow a similar approach to that of investment trusts, allowing investors to spread the investment risk over a number of companies by subscribing for shares in the VCT itself.
For the 2023-24 tax year the following limits apply:
For an EIS, the maximum annual investment you can claim tax relief on is £1m. This is increased to £2m, as long as at least £1m of this is invested in ‘knowledge-intensive’ companies.
Investments in an EIS can be carried back to the previous tax year.
For a VCT, the maximum annual investment you can claim tax relief on is £200,000. New investments in VCTs cannot be carried back to previous tax years.
VCTs may pay out tax free dividends to investors, although early-stage companies may not be able to afford this, without affecting growth, so investors certainly shouldn’t rely on receiving dividends. Dividends payable from EIS are taxable.
What are the risks of EIS and VCT schemes?
Despite the attractive tax benefits of these schemes, they are only suitable for people who are comfortable holding high-risk investments. This is because EIS and VCTs invest in smaller, fledgling companies that are inherently likely to be more fragile enterprises and could fail.
Another risk to consider is the illiquid nature of the investments as they are harder to sell than mainstream investments such as listed shares or unit trusts. As a result, such schemes are considered to be high risk and will normally only be suitable for a relatively small proportion of your overall portfolio.
If you are considering a long-term investment and want to maximise tax efficiency and diversify your portfolio, our independent financial advisers can provide you with expert guidance on such schemes, advising on the full range of investments and ensuring that the associated risks are fully understood.
Alternative Investment Market (AIM) investing
The Alternative Investment Market was launched 25 years ago (in 1995) with the aim of helping smaller companies that needed capital to grow but couldn’t afford the costs associated with listing on the London Stock Exchange, or were unable to meet the stringent requirements needed to float. As at Feb 2023 there were around 727 companies listed on AIM, with a combined market value of over £90bn.
Not all AIM-listed companies are start-up companies, but they tend to be smaller and potentially higher risk than those listed on the FTSE. The main investors in AIM shares will therefore normally be institutions and wealthy individuals.
What are the tax advantages of investing in AIM-listed shares?
Since 2014 investors have been able to include AIM-listed shares in their stocks and shares ISAs, meaning there is no Capital Gains Tax to pay on disposal and no Income Tax payable on dividends. More and more people, therefore, have considered including AIM-listed shares within their ISA portfolios in recent years.
Furthermore, most AIM stocks qualify for Business Property Relief and are exempt from IHT if held for more than two years, making this type of investment one for consideration when planning for inheritance tax.
As described earlier in this article, AIM shareholders are also able to benefit from Income Tax relief and Capital Gains Tax relief when the investments are held via an Enterprise Investment Scheme or Venture Capital Trust.
Considering EIS, VCT and AIM investments? Talk to us
These types of investments have grown in popularity over recent years, as they are now among the few remaining tax-efficient investment avenues still available to wealthier investors.
If you are unsure as to whether investing in tax-efficient vehicles such as EIS, VCT or AIM is suitable for you or you need professional advice on any other area of saving and investing, we are only a phone call away.
Don’t invest unless you’re prepared to lose all the money you invest. This is a high‑risk investment, and you are unlikely to be protected if something goes wrong – two-minute read IMPORTANT information about key risks.
Tax rules can change, and tax benefits depend on individual circumstances. The value of investments can go down as well as up and you may not get back the amount you invested. The past is not a guide to future performance and past performance may not necessarily be repeated.
This material is intended to be for information purposes only and is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Some information quoted was obtained from external sources we consider to be reliable.
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