1. The investment risk/reward characteristics of EIS and VCTs.
2. The role of EIS and VCT in an overall investment portfolio.
3. How changes to qualifying investment rules affect what can go into EIS and VCT.
4. The liquidity of investments in an EIS or VCT.
5. The main tax breaks on EIS, VCT and Business Property Relief.
6. How tax efficient investing can help clients make best use of their assets.
7. The role of EIS and VCT in pension and IHT planning.
Tutors on the panel are:
Paul Latham, Managing Director, Octopus Investments
Andrew Sherlock, Partner, Oxford Capital
PRESENTER: Hello and welcome to this Akademia session on efficient tax planning. We’re going to be looking at VCTs, EIS and business property relief. How they can be used as part of retirement savings and retirement income, and also the CGT and IHT planning opportunities that are out there. To discuss it, I’m joined now by Andrew Sherlock, he’s Partner at Oxford Capital, and by Paul Latham, Managing Director at Octopus Investments.
Andrew Sherlock, it’s the end of the tax year on the 5th April 2016, why should investors be thinking about using their EIS and VCT allowances before that date?
ANDREW SHERLOCK: Well the obvious answer is that they get lost if you don’t use them within a given tax year, particularly if you want to carry it back to the tax year 2014/15 to offset against income tax and so on. And this year there’s also the added incentive that if you, as many have in the past, wish to invest in energy or energy production, the last chance that you’ll have is this tax year, because as of the 5th April that is no longer a permitted activity for EIS. And for VCT it’s probably not dissimilar.
PAUL LATHAM: Not dissimilar but there’s another aspect for VCT as well. I think the supply will be shorter this year in the VCT market. So fewer VCTs have come out announcing that they’re going to raise money, and so the demand we would expect to still be as high as previous years. So I think there’ll be a danger of the best VCTs filling up before the end of the tax year. So I think it’s about getting in while it’s still available.
PRESENTER: Why are there fewer VCT opportunities?
PAUL LATHAM: So the changes that came out during last year through two budgets and an autumn statement, have meant that there’s some changes to the way that VCTs can invest going forward, and so some managers are sitting back and waiting for the dust to settle around that. If their particular investment strategy was impacted by those changes, they’re sort of regrouping and working out how they’re going to move going forward. And so those managers that are out there with investment strategies that are not affected will, I think, be in more demand.
PRESENTER: But in the great scheme of things does this mean there are now, there’s a smaller pool of potential investments for you to pick from if you’re a VCT manager, or is this just a temporary blip while people work out the new rules?
PAUL LATHAM: So I think while they work out the new rules is a good point. So the guidance has still not come out from HMRC. So although the legislation has been in place the guidance rules are still yet to be put in place. And so managers are still working out how it’s going to impact them. And there’s a lead into raising a VCT, so if it’s not available to understand in January then it’s too late to launch a VCT for the current year.
PRESENTER: And Andrew, you said it’s going to be tough to invest in energy, why is that a big issue, or is it a big issue?
ANDREW SHERLOCK: Well from an EIS point of view it is. I mean the Government for some time have been supporting renewable energy and energy generation. But in order to try and kick start I think particularly solar and anaerobic digestion and reserve power and so on, and the incentives that the EIS reliefs and VCT reliefs, tax reliefs have incentivised people to put money into this area, which is exactly what the Government wanted to happen. The areas are now up and running, and they don’t feel that they need these subsidies anymore because they can support themselves. And so they’ve withdrawn the ability to combine EIS reliefs with energy, or investing in energy.
So as from April as I say that’s not possible, but up until that point it is possible to invest in energy. And the attraction there is that it does give a relatively stable predictable cashflow, and the subsidies make the economics quite attractive.
PRESENTER: So does this mean from 6th April 2016 EIS funds will be higher risk higher reward than ones that have preceded them, because they can’t invest in this lower risk strategy?
ANDREW SHERLOCK: Well I think it depends on what strategies come forward, but certainly the EU has been driving the UK government to make changes. And as Paul alluded to, the rules have changed slightly, and they’ve introduced a growth and development test. And I think the general thinking of government is that these EIS and VCT reliefs are extremely attractive, and in order to quality for them there needs to be an element of risk taken.
Now in the early stages of solar and some of the renewable energy the risk was much greater than it was at the end. Going forward I think obviously energy will be off the agenda. And I think the mood music from government is to try and take a little bit more risk. Having said that there are various ways, notably through diversification, that you can mitigate those risks, and perhaps we can go on to talk about those a little bit more.
PRESENTER: Well, from your point of view, Paul, I mean we’ve been chatting about VCTs, you also do EISs at Octopus, are you going to change the number of underlying holdings you put in an EIS structure?
PAUL LATHAM: I don’t think it’s about the number of individual holdings. I think people need to look for diversification, not just by multiple holdings, particularly if those holdings are doing the same things. So it’s really about the number of holdings, it’s about diversification of investment strategies. Or using a VCT you can invest into an existing portfolio. So the benefit you have with a VCT that you don’t have in EIS is that a portfolio that’s already up and running as an established VCT with perhaps 50 holdings, some of which may be in energy because they were made last year and the year before, you can still invest in and still get access to those VCTs, and you’re also buying into some of the others already diversified across 30, 40, 50 companies.
PRESENTER: Just to pick up on that point, so if you are already in energy in EIS, or you’re in an underlying investment in VCT that from April you’re not able to be in, you don’t have to change your position.
PAUL LATHAM: Absolutely, really good point to make. This doesn’t, there’s no retrospective changes; it’s just new money being invested from the estate. So if you’ve got a VCT that portfolio is exactly the same tomorrow as it was yesterday. It doesn’t change the result of legislation simply with EIS investments that we’ve made in previous years, and right up until 5th April they stand, they will still be compliant with the rules.
PRESENTER: Now, Andrew, you were mentioning there about diversification, how are you going to get greater diversification for EIS?
ANDREW SHERLOCK: Well I don’t think it’s about great diversification. It’s more that some of the higher risk EISs, the risk can be reduced by diversification in lots of different ways. I think, picking up on Paul’s point here, there is a spectrum of risk across EISs, be they energy ones or growth EISs. And whether it’s earlier stage or later stage, whether it’s in one sector rather than another, whether it’s asset backed, whether it’s not. So I think Paul’s point, there are lots of different industries that quality for EIS, some of which are inherently higher risk, higher return than others, and so I think balancing that is sensible.
I think it’s not about diversifying across more companies per se. It’s about the point really was that by diversifying across be it eight or ten or six or eight or whatever the number is that different managers use, there is a spread of risk. And I think the key point here is from an EIS perspective that the tax reliefs are for each individual investment, not for the spectrum of investments. And I think it’s very important that people understand that the tax relief is an important part of the overall return. We expect on the higher risk EISs or higher risk companies some to fail. That’s why the reliefs are there. So part of anyone’s return will be tax relief on some of the things that haven’t worked, and equally on the ones that have worked, you know, they are capital gains tax free.
So if we look at a slide that we have here, there is an asymmetric risk reward profile from, and I’m just talking specifically about EIS but a lot of this relates in some part to VCTs, where your downside is protected. So if you’re a highest rate taxpayer at 45%, the most that you can lose on any individual EIS investment is roughly 38% of your money, 38½% of your money. And we can go through the maths on another day.
PRESENTER: We’ll take that as read.
ANDREW SHERLOCK: And equally on the upside any gain is capital gains tax free. So it cushions the downside and enhances the upside. Now that’s quite well known. What is less well known is that, as a point earlier on, is that this is for each individual investment. So if you look at the benefit across, and we’ve got a slide here, this is obviously very simplistic but it does illustrate the point. On this slide we have companies one and two, and the assumption is that in six companies £10,000 is invested in each. Companies one and two you’ll see double, so the proceeds of the sale are £20,000. Companies three and four stay the same, and company five and six go bust. So the amount that you put in was £60,000. The amount that you get out just from the investment return is £20,000 plus £20,000 plus £10,000 plus £10,000 is £60,000.
So you’ve actually made no money on the underlying investments. However the tax reliefs help compensate for some of this risk. So you get your 30% income tax relief for each of the companies. You then have a net cost, and if you lose that net cost, which is the £7,000 in companies five and six, you can offset that against income tax at your highest rate. So if you add up all of those different reliefs, your actually return is £84,300, i.e. it’s about 40% return.
Now this is stylised and simplistic, but it shows you that the tax relief is an important part of the overall return. And obviously you’d hope to have more winners than losers, but this illustrates a potential downside scenario.
PRESENTER: Well that’s some of the background on what’s happening with the Government tightening up how much tax reward you get for your risk. But I think another point I want to bring in here is there’s a general tightening up by government on the tax reliefs available to everyone. Paul, what’s driving this, and are they tightening up VCT and EIS at the same time?
PAUL LATHAM: So there definitely are changes. I think for VCTs in particularly last year was the most amount of change from the manager’s perspective, the fund manager’s perspective that we’ve seen for many years. Reiterate the point that from an investor’s perspective it doesn’t really matter. The product looks the same, but how we invest the money has changed. But I think there’s a broader environment here of changing tax legislation, pensions in particular is something that every year it seems there’s another slice of pension benefits that’s taken away, either changes in annual allowance or lifetime limits, that are necessarily forcing people to look for alternative ways to invest their money that will give them some enhanced returns from taxation benefits the Government have set up.
So that’s why we’re seeing, I think, more and more people, more and more mainstream people coming into VCTs and EIS because their pensions are effectively being capped out, and they’re not going to get any tax relief on those. And so they’re looking at an alternative.
PRESENTER: Well you mentioned pensions is one area where you’re able to make fewer contributions, but another area, IHT bands, Andrew, I mean they’ve been frozen for further and further out, what sort of impact is that having?
ANDREW SHERLOCK: Well I think EIS, all EIS companies qualify for business property relief, which is IHT, which effectively means that it’s IHT free if it’s held for two years. And I think it is having an impact. I mean there was a recent EIS Association survey or report that was put out that said that IHT planning was one of the top three reasons why people were investing, or why advisers were advising people to invest in EIS precisely because of this BPR benefit. And I think 76% of people, which is quite a high number. So there’s an EIS benefit; there’s also obviously options to invest in different BPR qualifying companies too. And the difference there is that BPR is inheritance tax free after two years, whereas other strategies such as gifting is more like, well it’s seven.
PRESENTER: Those are two areas, and the other thing that’s coming up is changes to tax rates on dividend income. Does that have much of an impact on how attractive VCTs or EIS would look?
PAUL LATHAM: There’s sort of a mixed message there I think. So VCTs have no tax on dividends anyway, so the increase in tax on dividends is not relevant to VCTs because there’s no tax on VCT dividends. EIS is taxed as a dividend, but most EIS companies won’t be paying out dividends. They’ll grow instead and the capital growth is tax free. So those changes are not really having much of an impact on the EIS and VCT world.
PRESENTER: Now, Paul, you were mentioning earlier about pensions so let’s come back to that. Firstly how easy, or how many people are now beginning to grate up against their lifetime allowance on pensions? And if you do what can you do about it?
PAUL LATHAM: Yes, I think that it’s definitely hitting more and more people every year. And if you look at some of the tables that have been put out in the press recently, relatively modest earners in their 30s and 40s will cap out even at today’s levels of lifetime allowance. And as we have seen they do change the rules. So we’re talking about lifetime allowance today, will that still be the lifetime allowance in 20 years’ time when that 30-year-old’s thinking about retirement? Maybe not, maybe they’ll be paying a penal rate of interest, a tax on that income.
So I think that that’s why people are looking for alternatives, and VCTs are one of those where you could think that instead of just putting all of your money into a pension, then there’s the alternative of going into VCTs. There’s lots of similarities, so pension you get grossed up in effect on the way in. A VCT is the same. You get that tax relief that means that the investment is worth more than you paid for it on day one. The difference of VCTs of course is it’s not taxed on the way out, whereas pensions are taxed on the way out.
And so if you look at those two different products purely from a tax perspective, VCTs are inherently more attractive, they attract more tax relief. And you can reinvest money in VCTs time and time again over your life, and get 30% tax break every time you do it. So it is quite a compelling argument to consider VCTs as part of your longer term financial planning.
PRESENTER: But given they’re that much higher risk than perhaps a mainstream equity fund that you would have in a pension.
PAUL LATHAM: Really good point.
PRESENTER: What should your considerations be there?
PAUL LATHAM: That’s often the challenge is that well you’d expect a higher return, it’s higher risk. Actually if you run the numbers and say we’re thinking about a VCT that’s generating a 4% return after all costs. In order to get the same return from your pension, depending on your tax rates, you’d have to be investing in your pension to get something around the 8, 9, 10, 11%. So you wouldn’t be able to invest in a FTSE tracker and get that sort of return. So actually in order to get the equivalent overall return you have to be invested in much higher risk in your pension. So they are higher risk but in order to get that return you have to make more risk in your pension. So I don’t think that you can just divorce the two and say higher risk therefore I’m going to disregard it.
PRESENTER: And from the perspective of EIS Andrew…?
ANDREW SHERLOCK: Quite similar. I mean one other point I would make is that also VCT and EIS investments are generally uncorrelated to any markets or any of the other mainstream things that might be in pensions. So I know it’s something we’ve discussed that arguably the risk comes down slightly because you’re diversifying your risk in uncorrelated things.
PRESENTER: And how do the benefits of EIS and VCT, if you’re thinking about your retirement planning in the round, so we’ve talked a little bit about pension, how does it compare to your ISA allowance, which is obviously the other thing that?
PAUL LATHAM: I’d make the same point about ISAs. The numbers are simpler there because you haven’t got different tax rates in terms of grossing up. But ISAs you don’t get anything grossed up on the way in, but there’s tax-free returns. So tax-free returns the same as you do for VCTs and EIS, but nothing upfront. If you make the same comparison you’d have to be generating 11% per annum in your ISA to generate the same overall after tax returns 4% in the VCT. So again they’re part of the planning but if you’re taking the overall return including the tax rebates, then you need to think about the additional risk that you have to take in the ISA to get an equivalent overall return.
PRESENTER: And for those that have already maxed out on the amount that they can put into a pension, Andrew, again any other ways they can be using EIS or VCT?
ANDREW SHERLOCK: Well I mean not only as an alternative investment, but also clearly mopping up or utilising some of the income tax that’s been paid is clearly an alternative tax efficient way of providing for the future.
PAUL LATHAM: One thing that we’re seeing is that people are drawing down from their pension. They’ll be paying tax maybe at 40% on part of it, and tax free for the first 25%. So a blended rate of 30% tax on what they were drawing from the pension. If they were to put that into a VCT or an EIS they get that 30% back. So a way of getting money out of your pension and into your own hands gives you the ability to do it effectively tax free. It’s locked up for three, four, five years, but after that you’ve got access to do whatever you like with it.
PRESENTER: So can you take your tax free pension cash and put that directly into an EIS?
PAUL LATHAM: You can yes, and in that way you’d clearly be up on the deal because you’re taking it out cash free and getting a 30% tax rebate. I’m saying if you took that out, some taxed and some non-taxed you’d end up with a blended rate of 30%, and then 30% back.
PRESENTER: Are you seeing a similar sort of thing in your clients?
ANDREW SHERLOCK: Yes absolutely, it can be used as a tool. I think both VCT and certainly EIS can be used as a tool to help unlock pensions in a tax efficient way.
PRESENTER: Well let’s move on from pensions to IHT, which we mentioned a little bit before. You’ve touched on business property relief there, Andrew. Most people’s life expectancy is going up, so why wouldn’t you simply rely on gifting if you were looking to get rid of assets now to make sure that you didn’t create an IHT liability?
ANDREW SHERLOCK: Well gifting is a great strategy provided that you survive seven years. But human nature is such that, I speak for myself and possibly many others that planning usually does slip, and sometimes it slips to a point where seven years is not an option or is a less attractive option. And perhaps as part of an overall strategy BPR might come into the equation for a proportion large or small of the estate planning equation.
So I’ve pulled together some numbers from the ONS which I think is quite interesting. And let’s take for a man of 70, the probability of a man of 70 surviving seven years and making the gifting strategy fully effective is 82%. The probability of surviving two years, i.e. using BPR as a strategy, is 96%. Now you may think they’re both pretty high, we’ll go with one rather than the other. However, if you look at an 85 year old man, the probability of surviving seven years is 34%. But surviving two is 80%. So I don’t want to go through all the numbers but it’s quite a stark difference between the two, which means that I think BPR does play an important role particularly in later planning rather than earlier planning.
PAUL LATHAM: I think that table plays to the logic. There is the emotional point, which is often much stronger that you alluded to earlier on of the well I might live way longer, why would I give away my assets now? What happens if I do live longer than the remaining assets can support me? I want to hold onto them just in case I need them for care fees or whatever I choose to do in later life. So most people are, even if they were young enough for the numbers to suggest that gifting is an option, that means they’re young enough that they may live an awful long while, and may have eaten through the rest of their savings before they’ve died. They’re not going to take that choice.
So the use of BPR is I think key to this planning because it gives you control and access if you need the money, it’s still yours, you haven’t given it away. Whereas if you put it into trust or given it to the next generation it’s outside of your ability to use it, you can’t now pay care fees from it.
PRESENTER: But it, sorry Andrew.
ANDREW SHERLOCK: I think that’s an absolutely key point, the control. If you give it away it’s gone. If you put it into a BPR strategy typically you might be able to get it back within a month or six months.
PAUL LATHAM: It’s just an investment; it’s your own investment.
ANDREW SHERLOCK: Exactly.
PRESENTER: But is there a danger that the legislation could be changed at some point in the future? We look at these tables, it seems a good idea, you leave it in BPR, but the chancellor likes to do a bit more than tinkering let’s be honest.
PAUL LATHAM: So I think that’s definitely a fair challenge is how much worse are you off because you’ve had it invested? You actually weren’t going to give it away in the first place, so the gifting is probably not going to happen, certainly not for substantial parts of your estate unless you’re very wealthy and setting up long term charitable trusts or something. So it’s just, it gives you the optionality that you wouldn’t otherwise have. Gifting for most people really isn’t an option; they don’t want to give up control. So why not have it in BPR, you’ve still got access to it, you’ll be earning a return on it like any other investment, why not?
PRESENTER: Well I think that’s covered IHT there. Another one I wanted to have a look at was extracting profits from a business. Now Andrew, in a scenario like that you’ve got a client that’s done very well out of their business, they want to take that money out, put it somewhere else, how can you use, let’s look at EIS specifically with you at the moment, how can that help?
ANDREW SHERLOCK: Well I think if you have a business and you pay yourself a dividend, then that dividend is taxed. And if you want to keep taking money from a dividend, from the company by way of dividend, you can use EIS by investing some of that dividend into an EIS. You release some of the, you have the 30% income tax relief from the EIS investment, which generally can offset the tax on the dividend, and also free up a small amount of cash. If you repeat that over a number of years it actually becomes pretty much self-funding. So it’s quite an effective way historically of being able to take money out of your company in a tax efficient way.
PRESENTER: So essentially you take your dividend, you pay tax on that. You take what’s left, put it into an EIS; it gets grossed back up again, overall roughly speaking.
ANDREW SHERLOCK: It does. It frees up a small amount of cash and then it becomes self-funding after, I think it’s three years.
PAUL LATHAM: The same thing with VCT. It’s much the same as the point I was making earlier on about pensions. If you’re accessing money and being taxed on it, be that a dividend on a payment, sorry tax on a dividend being paid out from your company or withdrawn from a pension, it’s a way of just using that cash that you’ve now got in your hand, invest it in VCT or EIS and get back the tax that you’ve just paid.
PRESENTER: And if you’re a businessman who’s got their own business, can you plonk that inside an EIS and then everything’s magically tax free without having to actually worry about all of this recycling?
ANDREW SHERLOCK: No.
PRESENTER: Right, there are rules about that are there?
ANDREW SHERLOCK: Many rules about that, and I would suggest taking serious advice before embarking on that sort of strategy. If you are involved and have a major shareholding, and are also a director and involved in a company there’s a whole plethora or rules that mean that that isn’t possible.
PRESENTER: I suppose the next tax that people talk about a lot is capital gains tax. If you’ve been building up a capital gains tax liability in something, Paul, how can you use tax efficiency to mitigate that?
PAUL LATHAM: It’s similar to the examples we’ve got. So we’ve talked about pensions and companies and taking money out of that. If you’ve got a buy to let portfolio, and you’re thinking about doing planning around that, tax planning around that, then you’ve got the same problem. Selling your buy to let portfolio could well generate a capital gains tax charge. So you can use EIS by investing the gain that you’ve just created by selling your portfolio, invest that gain into an EIS and you defer the gain for the life of the EIS. And so lots of clients will be buying EISs to defer the gain, and then will hold the EIS until they die, and that capital gain would die with them. It also means that the rest of the proceeds can also be used for inheritance tax planning.
So the EIS investment itself after two years, as we just heard from Andrew, is free of inheritance tax. The rest of the proceeds from your portfolio of buy to lets could be put into a BPR product that means that after two years that’s inside your estate as well. So all of a sudden you’ve translated something, this investment portfolio, into something that’s totally free from inheritance tax.
ANDREW SHERLOCK: Absolutely, and it could be that it’s not a buy to let portfolio but an equities portfolio. You know, if there’s a capital gain on that, often psychologically, you talk about the emotional psychology, psychologically people don’t want to sell the portfolio say at £700,000 with a £200,000 gain. If you sell it, it will go down to £644,000, you know if you pay the capital gain. But if you roll over the capital gain into an EIS, not only does your portfolio stay at the same level because the capital gain is rolled over, actually it increases by the amount of the income tax relief. So your portfolio actually goes up, and you’ve freed up in this case £½m to put into perhaps more appropriate assets.
PRESENTER: When you take, let’s say it’s property portfolio, it could be an equity portfolio, you take that money out and you put it into EIS. As you were saying, Paul, if you keep going, keep it in EIS until you die the liability goes but…
PAUL LATHAM: And it’s the gain that you need to invest as well. So in order to avoid the capital gains tax charge now, you only have to invest the gain, not the whole proceeds.
ANDREW SHERLOCK: So you’ve probably found the same. We’ve found that advisors who inherit a client who have an amount of money in a portfolio of assets, investments, whatever, that they feel is inappropriate. One of the battles, and they want to try and move it into something that is appropriate, one of the battles is how do you do that without losing the value that we just talked about? And so by crystallising the capital gain and investing that proportion in EIS you free up the rest of it to do other things. And that can be a very effective tool for advisers who are looking to transition portfolios or perhaps have taken on a new client with a portfolio they don’t feel is appropriate.
PRESENTER: But I take that crystallised capital gain and I put it into an EIS. But, I might be being naïve here, do EISs just run on forever, what happens if after five years I’m with you, do you say well actually Mark, that EIS has just rolled up, do I then have to roll it over?
PAUL LATHAM: It depends on the manager.
PRESENTER: What would I need from a manager to make sure that gain?
PAUL LATHAM: So we run out EISs as long as you like. So some managers will wrap them up after three, four, five years. But then you can just reinvest into another EIS. So again you get the ability to…
PRESENTER: That doesn’t crystallise anything.
PAUL LATHAM: No, you crystallise it and then you defer it again, so you’ve got the same effect. So you can either have serial EISs, and if you can use the income tax relief then you’re generating another 30% income tax relief every three, four, five years, as you sell and reinvest. And then you continue to defer the capital gain, and your inheritance tax protection rolls through that as well, as long as it’s invested at the time of death you’re OK.
PRESENTER: Given how generous some of these tax breaks are, admittedly in return for taking a certain amount of risk, are you not worried that the Chancellor might start to look at them down the line?
PAUL LATHAM: Well they have tweaked over the decades that they’ve been in place, but the fact that they’ve been around for decades through every different colour of government suggests that all chancellors realise that this is something that is important to the UK economy. It stimulates the growth in companies that are really important. Zoopla is an example that we have in our portfolio, where we took it from a pre-revenue stage using EIS and VCT money, and grew it into a company that eventually floated at now around a billion pounds. So it’s exactly what the chancellor wants. Yes, it costs him a bit of income tax relief upfront, but that’s now a massive company with loads of employees paying income tax, paying capital gains tax and paying national insurance. There’s a real benefit to the economy from that.
ANDREW SHERLOCK: There’s a real payback as well. For every pound of relief the stats are that they get their money back within, pretty much within a year with some of these VAT and corporate tax, income tax and so on.
PRESENTER: Now just very quickly we were talking about CGT, and we were talking very much about how you can use EIS to defer crystallised gains. Do VCTs have a similar…?
PAUL LATHAM: No, many years ago that was possible. That’s not been possible for a long while now.
PRESENTER: But if any chancellor would like to revisit that you would be a big fan of it.
PAUL LATHAM: Yes, I think it’s unlikely. I don’t think they’re going to be making the tax breaks any more attractive. But they have changed over the years and they’ve bounced around from 20 to 40 to 30%, and so it’s possible. But I don’t think that there’s any intent to just take away these reliefs. They’ve put a lot of effort into getting them approved by the European Union very recently to make sure that they comply with the EU rules, so a lot of effort.
ANDREW SHERLOCK: Yes, I mean I think it’s worth, if one looks back over the last four or five years there’s been a consistent opening up of the reliefs. Originally on EIS it was 20% income tax relief, it then moved to 30%. The amount that you could put into an EIS doubled a few years ago from £½m to £1m a year. There has been a consistent strategy of opening these things up. And within Europe I think EIS is viewed as the sort of poster child for trying to channel money into areas in which the economy needs it. Just echoing your point in terms of the, when companies, you know, it can breathe much needed life into companies that otherwise perhaps wouldn’t.
I mean we came across a little company called Oxitec that was about £3m. And recently we sold it for $160m, which is great. But much more exciting was the fact that this was involved in tackling dengue fever through mosquitos, and being able to add a gene to a mosquito which meant that when it mated it died, it crashes the population of the mosquitos that are carrying dengue fever. And rather topically it also is the same mosquito that is responsible for the Zika virus too. And so be it a Zoopla or an Oxitec, there’s lots of good things that come from it, not just employment but also broader issues too.
PRESENTER: Now we’ve talk around a lot of the taxes, but just very quickly income tax, particularly for those, Andrew Sherlock, who perhaps have lost their personal allowance. How can EIS and VCT help you there?
ANDREW SHERLOCK: Well in the sense of if you’re, as part of your overall strategy and it’s appropriate, if you wanted to invest in an EIS then clearly if you have an income tax bill you can offset a proportion of that when you invest in an EIS. So effectively you’re creating your own personal allowance through investing in some of these opportunities.
PAUL LATHAM: And I think what’s not often understood is that it’s not just income from employment that you can offset against. So pensions as you know can only be used against earned income, so income from employment. But the tax reliefs from VCTs and EIS can be used to offset income from other sources. So someone whose income is generated just through a buy to let portfolio for example, cannot use those earnings to put into a pension and get those grossed up. But you can use them in VCT or EIS, and so very attractive for those people because they haven’t got a pension as an alternative.
PRESENTER: And for couples that are married can you, what can you do to put money into each other’s allowances, or are you not? Because with pensions there’s a very strict limit for example as to how much you can put in on behalf of say a non-earning spouse, what are the rules around EIS and VCT?
PAUL LATHAM: The rules apply to EIS and VCT as they do to any other investment, which is very flexible - which means that I could buy it and give it to my wife, and so I’ve got the income tax benefits but can give the investment to her. She could then get the earnings from that VCT or EIS in her name against her income tax bill. So very flexible, it’s an important way of making sure that you can balance between spouses or civil partners.
ANDREW SHERLOCK: I mean the limit as I mentioned earlier on is a million pounds per person per year. So the limit is pretty high. I guess the more self-select limit is the amount of income tax that you have between you, and that would link the appeal both in the year in which you’re investing but also in the previous year too.
PRESENTER: Now just to bring to a conclusion, we’ve talked a lot about what the benefits are. But if you’re an adviser and you think well I like that, but how sure can I be that the Revenue will agree, particularly with this EIS is yes, that does qualify for an EIS, what are the forms, what are the degrees of security and paperwork you need to have so that you feel comfortable putting your reputation and your client’s money into one of these products?
ANDREW SHERLOCK: Well there’s a process to answer that exact question called advanced assurance, where before, certainly from our point of view, before we’ll invest in any company we write to the Revenue and say we want to invest in this company, this is what it does and this is how it does it. Will it qualify for EIS reliefs? And the HMRC inspector looks at it, you know, evaluates everything that we’ve put down, and then generally says if it’s appropriate will say yes, I will give you advanced assurance that that will qualify for EIS relief.
Now we won’t invest in anything unless we have that. And there’s never, to my knowledge anyway, ever been a situation where having given advanced assurance the Revenue has reneged on it, unless of course you say you’re going to do one thing and do something completely different. But if you do what you say and you have advanced assurance that is, as I say in my understanding there’s never been an instance where that has not been upheld. So I think on that basis the risk is extremely low.
PAUL LATHAM: Yes, and VCTs work in exactly the same way, you go to the Revenue. Andrew made it sound quite simple. The submission to the Revenue is actually quite extensive. It lays out all the business plans, the cash flows, it goes into a lot of detail, and that’s necessary to make sure the inspector can look at it and really understand what that company is doing, and make sure that they’re happy that it will comply with the rules. And, as Andrew says, the presumption is, and it’s not been proved wrong, that if you’ve got the advanced assurance then the tax relief will follow.
PRESENTER: Has a VCT ever lost its status and just become an old fashioned investment trust?
PAUL LATHAM: Some VCTs have chosen to cease to be VCTs, and then they would become an investment trust. But none have been inadvertently, have inadvertently lost their status. There was the instance a year or so ago where there was a challenge by HMRC to one VCT. They then withdrew that challenge having investigated the situation. So no, there’s never been one withdrawn. In some cases VCTs have given up that status because they’ve merged or they’ve gone in a different tack.
PRESENTER: All right, well we’re almost out of time so I’m going to ask you each in turn for a final thought. EISs, what’s the outlook, what should people be considering them, not just before the end of the 2015/16 tax year but beyond?
ANDREW SHERLOCK: Well we’ve touched on a number of the drivers. One is that there are very limited or increasingly limited options available to invest in a tax efficient way. Pensions and so on are becoming much more challenging in order to, and limited in scope. So I think that there’s a natural propensity to look elsewhere. I think the EIS market, generally, and the providers are becoming much more professional, and have done over time. I think there’s quite a lot of exciting companies that are coming through. And I think in any environment of high taxation the incentives that EIS offers, the tax reliefs that it offers are extremely attractive. And therefore would probably form a useful part of people’s overall investment planning as a whole, a part of it depending on what their risk appetite is, and what the rest of their portfolio looks like. So I think the future for EIS is bright.
PRESENTER: Paul Latham, what’s the outlook for VCTs?
PAUL LATHAM: Yes, I’d echo everything that Andrew said, because lots of things apply to VCTs are well. I think the thing I would add that applies to VCTs is there’s an ability to buy into large portfolios of existing companies that have already proved themselves and are moving up that growth curve. So many of the VCTs now are hundreds of millions in size. So you’ve got broad portfolios of companies right across the spectrum, early stage to very mature. And the ability to get into a balanced broad portfolio like that that’s diversified, and also get a tax break to do so I think is very attractive, is a compelling argument. And what I’ve been increasingly pleased by is that investors really like the idea that the companies that they invest into have done some good.
The example of the mosquitos, the people who have invested in that will feel good about that. The people who look at a Zoopla advert and know that they were part of taking it from an idea in a garage to a big company that’s now advertising on TV, actually makes them feel good about how they’ve used their money. And it’s doing good for them, it’s doing good for the country. We talked about renewable energy earlier on. There’s a real emotional benefit from these sort of investments. It’s not just about return and the tax breaks, it’s also about giving back, doing something that’s helping the economy and helping the environment in many cases.
PRESENTER: We have to leave it there. Paul Latham, Andrew Sherlock, thank you both very much. And thank you for watching. Do stay with us. We’ve got some learning outcomes coming up in a moment which you can use as part of your structured CPD. Goodbye for now.
In order to consider the viewing of this video as structured learning, you must complete the reflective statement to demonstrate what you’ve learned and its relevance to you. By the end of this session you will be able to understand and describe the role of EIS and VCT in retirement planning, the use of EIS to manage a potential CGT liability and the role of business property relief in IHT planning. Please complete the reflective statement to validate your CPD.