You’ve come into some money and want to invest in a tax-advantaged scheme, either an enterprise investment scheme (EIS) or a venture capital trust (VCT). The tax breaks for these are similar but with important differences. What are they?
Riskier investments
Investing in companies always carries a risk and in enterprise investment scheme (EIS) companies or venture capital trusts (VCT) even more so. If you’re new to these types of investment or are unsure about putting money into higher risk schemes, we recommend that before you take the plunge you speak to a financial advisor. It’s worth comparing the different tax breaks for EISs and VCTs as they might help you decide where to put your money.
Income tax relief
Both EISs and VCTs offer the same rate of income tax relief which is given in the same way. The tax relief is equal to 30% of the amount you invest (this can be proportionately reduced if the company or fund you invest in uses some of the money for a non-qualifying purpose). The tax relief is given as a reduction of your tax bill. This means it doesn’t matter what rate of income tax you pay the amount of tax relief you’ll get is the same. For example, if you invest £20,000 in an EIS or VCT your tax bill is reduced by £6,000 (£20,000 x 30%).
The main differences in EIS and VCT income tax relief are:
- you can carry back EIS tax relief from the year of investment to the previous one. Among other advantages this accelerates the tax saving
- the tax relief is clawed back if you sell or transfer an EIS investment (unless it’s to your spouse or civil partner) within three years of making it. The claw-back period is five years for VCTs
- dividends (distributions of income) from VCTs are tax exempt but those from EIS companies aren’t; they are taxable under the normal rules for dividends.
Capital gains tax deferral
If you have a capital gains tax (CGT) bill for the year of investment, or the year before, EIS investments offer an incentive VCTs don’t. You can claim deferral of the capital gain until you sell or transfer (to someone other than your spouse or civil partner) the investment. For example, if you made a taxable capital gain in 2020/21, you could defer when it’s taxed by investing in an EIS company on or before 5 April 2022 and using the carry-back rule we mentioned earlier to claim the tax relief for 2020/21.
Investment gains and losses
If you sell an EIS or VCT investment for more than you paid for it the gain is tax exempt. For EIS, you must own the investment for at least three years before the exemption applies. If you make a loss from the sale of an EIS investment you can use it to reduce the taxable gains made from other sales or transfers of the same or later years, e.g. from selling an investment property. Conversely, you cannot claim tax relief for losses made from the sale or transfer of a VCT investment.
Tip. As a rule of thumb, EIS investments tend to be riskier than those in VCTs but successful EIS investments usually produce greater income or gains. However, there’s no certainty of success.
Take your pick. EIS investments have the added incentive of CGT deferral relief. However, if you’re looking for a tax-free income stream VCTs provide it whereas EISs don’t.
While the rate of income tax relief is the same, EIS relief can also be used to reduce your tax bill for the year of investment or the previous year. EIS investments also allow you to indefinitely defer capital gains tax liabilities. All income and capital gains from VCT investments are tax exempt whereas income from EIS investments is taxable.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.