With some investors now subject to 50% income tax and others being caught by the 40% rate for the first time, higher-rate taxpayers are on the hunt for ways to shield their money from the taxman as the end of the tax year approaches on 5 April. Two schemes – venture capital trusts (VCTs) and enterprise investment schemes (EIS) are being marketed heavily. But should you get one?
VCTs are listed funds that invest in small start-ups. They offer 30% income tax relief on investments of up to £200,000 per year if you invest the full amount. To keep the income-tax relief you have to hold the investment for at least five years. That’s quite a long lock-in, but you will also benefit from not having to pay higher rate tax on dividends, or capital gains tax on any gain. So far there’s plenty to like here. But the risk is letting tasty tax breaks cloud your investing judgement.
VCTs’ performance as investments is mixed. A typical VCT yields around 5%. Not bad – but any capital growth depends on the underlying investments. Investing in start-ups is very risky, particularly in the current uncertain climate. For example, according to Chelsea Financial Services, Ortus VCT has lost 44% since its 2006 launch. Your investment will also be hit pretty heavily by charges. Initial fees are around 3%-5% and annual charges between 0.5% and 2%.
There is speculation that the chancellor, George Osborne, may end the generous tax breaks on VCTs, but for now investors appear safe. Ben Yearsley, investment manager at Hargreaves Lansdown, favours asset-backed VCTs, as they can retain their net asset value even if the underlying businesses struggle. The Downing Absolute Income VCT2 (LSE: DA2O), for example, invests in firms such as restaurants or pubs.
An alternative, also with juicy tax breaks, is an EIS. You can put up to £500,000 per tax year into an EIS, meaning the 20% income-tax relief can be worth up to £100,000, provided you stay invested for at least three years. Like a VCT, there is no CGT payable on gains either, after three years. But as unlisted investments, EIS shares can’t be traded and investors must stay invested until the fund chooses to sell. This makes them a “very illiquid investment”, says Hargreaves Lansdown.
Also, many schemes not only invest in small companies (gross assets under £7m), but also in fewer companies than VCTs. No wonder Hargreaves Lansdown describes them as at “the top end of the risk scale”. Throw in high fees – eye-popping 9.5% initial fees for the Shelley Media EIS – and it’s obvious these schemes are only for adventurous investors with a big risk appetite.