Investing in fledglings is now more appealing

THE Budget increased the tax breaks available for the enterprise investment scheme (EIS) and sorted out some of the legislation involved in venture capital trusts (VCT). This is making both look appealing to investors, especially those desperate to escape the burden of the 50p tax rate. Here’s your guide to what they are and how they are changing.

VCTs were introduced in 1995 to encourage investment in a portfolio of smaller, unquoted companies trading wholly or mainly in the UK.

VCTs offer individuals a 30 per cent income tax rebate on an investment of up to £200,000 a year, so long as the shares are held for five years and you have paid that much tax. You are not liable for income tax on dividends and when you dispose of your shares there is no CGT, should they be trading above issue price. Bear in mind the market can be illiquid, making disposal difficult, something also true for EIS.

The EIS was launched in a similar manner to VCTs a little later on, but with the aim of getting people interested in higher risk, smaller companies. The projects had some teething problems (a few remain) with arbitrary lines drawn between qualifying and disqualified companies and the tax breaks offered on each. Currently you can invest £500,000 a year and receive an income tax rebate of 20 per cent.

From 6 April 2011, the EIS will offer a rebate of 30 percent to match VCTs. As of April 2012, EIS investors will be able to invest £1m a year and both schemes will be able to invest in larger companies.

The government is also consulting on improving the situation for investment in smaller companies, simplification of the rules and the removal of some restrictions. Anything, it seems, to get people putting money into start-ups – which investors should remember is still a genuinely risky business.

Many of the proposed changes still need to be nodded through by the EU, but are likely to be implemented in this year’s Finance Bill.

EIS and VCT investments probably shouldn’t be more than 5-10 per cent of your portfolio, but if you pay enough income tax, then VCTs and the EIS offer a substantial rebate – at the price of higher investment risk. One advantage of the EIS is that 40 per cent loss relief can be offset against gains elsewhere.

Fees can be high for both and you should consider the total expense ratio (TER) as well as likely performance. An independent financial adviser will be able to help you consider which is best for you.

But Patrick Reeve at Albion Ventures characterises the difference between the two: “VCTs tend to be less risky affairs because – if they are like ours – then they are diversified and the risk is spread across the product. EIS are slightly higher risk because they usually invest in smaller, less established companies. Higher net worth individuals tend to go for them.” VCTs and the EIS are a chance to invest in UK enterprise, but research carefully first.