Why the extension of the Sunset Clause has ignited interest in VCTs and EIS

In his Autumn Statement, Chancellor Jeremy Hunt officially prolonged the sunset clause for Venture Capital Trusts (VCTs) and the Enterprise Investment Scheme (EIS) until April 2035, by Oliver Warren

Initially established in compliance with European Union state aid regulations, the sunset clause limited relief eligibility to subscribers of shares issued before April 6^th 2025.

Following this change, investors’ curiosity has been sparked – what are VCT and EIS funds, what is the difference between the two, and how they can most effectively make use of these tax-efficient investment offering?

Over the past decade, the VCT and EIS markets have seen significant growth, fuelled by increased awareness and a tightening of pension contribution allowances. Both schemes aim to channel private risk capital into small UK companies, fostering innovation, job creation and economic growth. These UK based venture capital investments, offer attractive tax benefits and low correlation to mainstream markets, making them appealing to investors seeking to back British businesses alongside tax efficiency, portfolio diversification, and potentially high returns.

VCTs and EISs are particularly beneficial for higher-rate taxpayers looking to minimise their income tax liability and investors aiming at tax-efficient retirement savings beyond annual pension contribution limits.

While sharing common ground, VCTs and EISs have distinct features that may make one more suitable for individual investors than another.

EIS – lesser known but powerful

In the vast landscape of investment options, the EIS stands out as a lesser-known yet powerful vehicle that offers investors a unique combination of potential returns and substantial tax advantages. The scheme was introduced by the UK government in the 90s to stimulate investment in small and growing businesses across the UK. EIS provides a generous incentive structure designed to attract private investors.

Key tax benefits of the EIS:

• Income tax relief: The cornerstone of EIS is its impressive tax relief structure. Investors can claim Income Tax relief at a rate of 30% on investments up to £1 million in a tax year. This means that if an individual invests £100,000, they could potentially reduce their Income Tax bill by £30,000.
• Capital Gains Tax (CGT) deferral: EIS also allows investors to defer Capital Gains Tax on gains made elsewhere if the capital gains are reinvested in qualifying EIS shares. This deferral can provide a valuable tool for investors looking to manage their tax liabilities strategically.
• Inheritance Tax (IHT) exemption: EIS investments, if held for a minimum of two years, are generally exempt from Inheritance Tax. This makes EIS an attractive option for individuals seeking to pass on wealth to future generations while minimising tax implications.
• Loss relief: Recognising the inherent risk associated with investing in smaller companies, EIS provides a safety net through loss relief. If an EIS investment turns out to be unprofitable, investors can offset up to 45% of the net investment against their income or capital gains, further mitigating potential financial setbacks.
• No CGT on EIS profits: If an investor makes a profit on their EIS investment, it is generally free from Capital Gains Tax. This can significantly enhance the overall return on investment compared to other taxable investments.

With EIS, investors can commit up to £1 million per tax year, receiving a 30% income tax relief for a minimum three-year holding (or £2 million for “knowledge-intensive” EIS investments). Unlike VCTs, EISs do not offer tax-free dividends, focusing on long-term growth. It is also worth bearing in mind that investors will receive a tax relief certificates per company investment. Additional benefits include loss relief, IHT relief after two years, and CGT deferral.

VCTs – a tax-free yield

Investing in a VCT involves buying shares in a London Stock Exchange-listed Investment company, like the Calculus VCT, that predominantly invests in UK venture capital. Investors can commit up to £200,000 per tax year, and will gain access to a diversified portfolio of fledgling companies focussed on the fastest growing areas of the UK economy, such as healthcare and technology. This diversification into normally at least 30 companies, spreads the risk across multiple ventures and helps mitigate the impact of potential losses from individual investments. EIS funds are usually a bit more concentrated, offering anything from 4 to 10 companies.

Key features/benefits of a VCT:

• Income tax relief: a 30% income tax relief, provided the investment is held for at least five years.
• Tax free dividends: Dividends from VCTs are entirely tax-free, making them attractive for generating additional income without incurring a tax bill.
• Tax-free capital gains – If you decide to sell your VCT shares and you make a profit, the proceeds won’t be liable for capital gains tax.

Entering their third decade, VCTs and EISs offer diverse benefits to investors, each carrying inherent risks but accompanied by substantial tax advantages. These schemes are particularly valuable for wealthier investors who have exhausted traditional savings routes. Due to the complexity of tax planning, seeking professional financial advice before investing is recommended.

 
Oliver Warren is Associate Director at Calculus