ISA season is truly upon us now, but our users are thinking about much more than just how to make the most of their allowances. Tax-efficient investments, wills and how to pass pensions on optimally are also top of the agenda.
Opportunities abound in tax-efficient investing, with products to suit all kinds of individuals, argues Jack Rose, Business Development Director for Tax Products, LGBR Capital.
Enterprise Investment Schemes (EIS), Venture Capital Trusts (VCTs) and Business Property Relief (BPR) products are by no means new in the market place and have become very popular strategies among affluent individuals in the UK. BPR was first introduced in the 1976 Finance Act and EIS replaced the old Business Expansion Schemes in 1994, whilst VCTs were introduced in 1995.
Whilst figures for assets raised in BPR schemes are hard to come by, the 2013/2014 tax year saw a massive £1bn raised across EIS and VCTs. Since their inception EIS vehicles have attracted over £10.7bn and VCTs over £5.4bn into the UK SME sector (according to HMRC and the Association of Investment companies respectively).
Yet despite all three structures having an established market with a tracking record spanning over 20 years, many financial advisers still do not include them in their tax planning arsenal – even though recent changes in government legislation have made the case for these tax-efficient structures even more compelling.
The introduction of GAARs (General Anti-Abuse Rules) and DOTAS (disclosures of tax avoidance schemes) has been described as the “kiss of death” for aggressive tax avoidance schemes; few will have missed high-profile cases that have played out in the tabloids over recent years. This is leading many independent advisers, who are additionally being exhorted to demonstrate a “whole of market” approach by the regulator, to look towards government-approved EIS, VCTs and BPR to further their clients’ tax mitigation aims.
Each of the three structures – EIS, VCTs and BPR – offer a number of different tax incentives, allowing them to fulfil different needs in an investor’s portfolio. Choosing the right approach will certainly call for an in-depth discussion with your wealth manager. For example, VCTs offer tax-free dividends to investors, meaning they may be more suitable to an investor looking to maximise income.
However, a golden rule of investment is that you don’t get anything for free. The generous tax incentives offered by the government are designed to offset the risk of investing in smaller, unquoted companies.
Furthermore, investments into these strategies must meet certain criteria both at the investor level (such as minimum holding periods to qualify) and the underlying investment level (such as a maximum revenue size or staff headcount). With the higher-risk nature of these strategies, they are not always suitable for every investor but for a client with the right kind of profile and needs they can form an important part of an investor’s portfolio.
The support of successive governments for EIS, VCTs and BPR investments should reassure investors as to their future. As well as progressively more generous reliefs on offer, there are a number of other factors driving the growth in the market.
Firstly, recent changes in pension rules (the annual and lifetime contributions limits coming down to £40,000 and £1.25m respectively) combined with new freedoms to take drawdown rather than purchase an annuity has meant advisers have a series of alternative pension planning investments to consider, including VCT products in particular. The tax-free dividends offered by VCTs make them an attractive alternative source of tax-free income that can complement a traditional pension portfolio, for instance.
Secondly, inheritance tax continues to be an ever-growing problem for advisers and their clients, exacerbated in areas such as London and the South East by rising property prices. BPR strategies offer a simple way for investors to reduce their IHT liabilities after just two years. Furthermore, BPR strategies offer a flexibility, control and timescale that traditional estate planning options, such as trusts, often cannot (clients can often be uncomfortable with the idea of taking assets outside of their estate when they might be required later).
Lastly, the dynamics for SME asset raising through EIS and VCT structures continue to be favourable. Seven years on from the 2008 financial crisis and, despite the more recent economic upturn, the market for SME funding remains well below pre-crisis levels. With traditional sources of funding difficult to secure, demand for funding via EIS and VCTs far outstretches supply. This has created a positive environment for EIS and VCT managers with a number of potential deals in which to deploy new cash.
There are a huge range of EIS, VCT and BPR products available in what is long-established, multi-billion pound market that provides vital investment into the dynamic UK SME sector. Each structure provides a different range of tax planning benefits, which can fulfil a range of clients’ tax planning needs as well as the potential to generate attractive returns.
For a great many reasons, these structures can form a valuable part of your adviser’s tax planning arsenal, with the market and demand only set to grow.
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