This forms part of the FSA’s on-going focus on unregulated investment products, and proposals made in last August’s consultation paper would restrict the selling of these funds only to “sophisticated investors”.
VCTs have raised more than £300m in each of the last three tax years, with £325m in 2011/12 and EIS investments last year estimated to have been more than £400m. Both schemes enable qualifying SME companies to raise equity investment and then subsequently obtain external finance which would not otherwise be available to them.
VCTs are investment trusts that invest in unquoted shares, which can include some AIM and PLUS market shares. Shares are listed on the London Stock Exchange and there is a secondary market in the shares. But as they operate in a similar way to investment trusts that are specifically excluded from UCIS, there is strong lobbying at present for VCTs in particular to be excluded from this ruling.
Investors in VCTs obtain 30% income tax relief on their investment and all income (ie dividends) and gains are exempt from tax. Post-tax relief rates of return on VCTs are generally in line with equivalent investments, but it is necessary to look at individual performance. In 2011, 50% of the ten top performing investment companies were VCTs. VCT investors also benefit from tax free dividend income so it is important to also consider the yield. The VCT Generalist sector after tax yield currently is in excess of 7%.
With an EIS Fund on the other hand, investors’ money is placed across several companies with the intention of spreading the risk. The investment performance varies significantly and therefore it is important to take this into account and not make investment decisions based purely on the significant tax reliefs available.
Investments under EIS can be either directly in an individual qualifying company or via an EIS Fund, and post-tax relief investment performance of EIS individual companies varies enormously. The tax reliefs available do in part limit your downside in the case of a business failure. For a 50% tax payer, the net position would be:
Initial relief at 30% (30)
Net investment 70
Set against other income 50% relief (35)
Net loss 35
It will be interesting to see the outcome for VCTs and EIS from the consultation process on UCIS. There are serious concerns if they are not specifically excluded then it will significantly reduce this vital source of funding for SME companies, at a time when obtaining external funding, including bank finance, is still extremely challenging. Support to help SMEs develop and grow is crucial to the future of our economy.