How has the Budget changed the rules for the Enterprise Investment Scheme and Venture Capital Trusts?
The changes will mainly affect the new tax year 2018/19 and it’s important to highlight that the main tax incentives for investors are staying the same—income tax relief at 30 per cent on both EIS and VCT, no tax on capital gains, deferral of capital gains tax payable on funds subscribed to EIS investments, and tax-free dividends from VCTs.
What has changed is that the Treasury will no longer give tax relief on EIS investments it believes are “capital preservation schemes.” That means tax-motivated, low-risk investments where the main return comes from the 30 per cent tax relief—the Treasury estimates schemes like this accounted for about half the EIS market. Going forward, the money will have to be invested into growing, entrepreneurial companies. This is a definite attempt to focus these schemes in line with the spirit of the original legislation.
How about the VCT changes?
These were less about capital preservation schemes and more about increasing the pressure on VCTs to invest a higher percentage of their funds into growing companies – the minimum is going up from 70 per cent to 80 per cent, with rest in low risk cash deposits—and to invest it faster. From April, VCTs will have to invest 30 per cent of the funds they raise within a year of raising them. That may cause a problem for some VCT managers because there have been some very large fundraisings recently that will now have to be invested more quickly than the managers might have expected, so the pressure on them to put the money to work will increase.
Why has the government made these changes?
Three main reasons: they were concerned about giving tax-breaks meant for investment in entrepreneurial, growth companies to low-risk capital preservation schemes; the Treasury wants to do more to tackle low productivity growth by encouraging more investment in technology and science-based companies—the so-called “knowledge intensive companies”—meaning they focused on R&D—and finally it wants to ensure more money is channelled to “scale-ups,” meaning young companies that are succeeding but need more funds to achieve their full potential. That’s an area where the UK is weak compared to other major economies.
What does all this mean for investors?
The major point is that, going forward, EIS and VCT will both be tax-advantaged vehicles for investing in smaller growth companies. Historically, that hasn’t been the focus of some EIS and VCT managers, especially those focused on capital-preservation schemes that the Treasury have banned. So, for investors it’s very important to look at the experience and history of the manager you are considering: do they have a record in growth company investing or are they trying to shift their focus because of the impact of the new rules? Remember, in the past most VCTs were smaller MBO investors (which are now not allowed) not growth investors.
I’m a big supporter of the changes and I firmly believe EIS and VCT are still attractive and capable of delivering above-average returns. They still have a place in the portfolio of appropriate, high net worth investors, typically no more than 5 per cent-10 per cent of their portfolio. With regard to VCTs, we are likely to see fewer very large VCT fundraisings because of the pressure on managers to put those funds to work.
And what will the impact be on Calculus?
The changes will not have a big impact on us because we’ve always been investors in small, growth companies, originally through our EIS funds and our VCT has always been careful about how much it sought to raise. We focus on areas such as healthcare, applied technology, by which we mean companies that use technology, such as Artificial Intelligence, to improve efficiency, advanced manufacturing and the leisure sector.
The salad bar chain, Chop’d, is an example of one of our leisure investments. Both our EIS and VCT schemes invest in the same universe of growth companies and we are going to carry on doing what we’ve always done. Thankfully we aren’t sitting on a large pile of funds that we are under pressure to invest more quickly than we had expected. We’ve always been very careful not to raise more than we felt we could invest within the appropriate period.
How should people decide between EIS and VCT if both are focused on the same area?
It’s really a question of what your priorities are as an investor. In recent years we’ve seen a lot of interest in EIS investments because they are inheritance tax-exempt, which for some investors is a key concern. Also, pensions changes over recent years mean a lot of wealthier people have effectively reached their ceiling on lifetime pension contributions and they’re looking for something that can make up for their reduced ability to contribute to pensions.
In terms of investments, EIS investors tend to be closer to the companies in their portfolio, while VCT investors buy shares in a vehicle that invests in growth companies, so they’re necessarily a bit more remote from them. People often prefer one arrangement to the other, according to their personal interest. But from our point of view we’re investing in the same range of companies through both vehicles—the question is what suits you as an investor? Are you looking for inheritance tax relief plus a range of other tax benefits and a companion to your pension in which case EIS may be more appropriate? Or, are you more interested income tax relief and regular tax-free dividends in which case investment a VCT may be more suitable.
The Calculus EIS fund and the Calculus VCT are both open for investment. Calculus is offering Prospect readers a 0.5% early-bird discount until 9th February on the Calculus VCT. Its VCT offers 30 per cent income tax relief upfront and targets a tax free annual dividend of 4.5%. For further information please get in touch: info@calculuscapital.com or +44 20 7493 4940
