The Government may be keen to restrict high earners in their ability to build a pension fund that will see them comfortably through retirement.
But when it comes to encouraging the same people – 40 and 45 per cent rate taxpayers – to back newish businesses, they are more than generous. Tax breaks galore.
The savings vehicle in question is the enterprise investment scheme, as risky as a swim in a tank of piranhas but a clever (and legitimate) way of sheltering income from the claws of Philip Hammond, Chancellor of the Exchequer (for the time being at least).
For those who still have surplus income they want to shovel into a tax-free savings home – and are already fully using ISAs – an enterprise investment scheme is a viable option
The scheme is certainly an option for those who have already accumulated a pension that in value exceeds the so-called lifetime allowance.
Currently set at £1,055,000, this limit (Hammond, it’s not an allowance) can only be exceeded by pension savers if they are prepared to accept that the excess will be taxed to the hilt when they draw an income from their fund – in some cases, a tax charge of 55 per cent.
It should also be considered by those who are planning in the months ahead to use their maximum annual pension allowance. This stands at £40,000 – including employer contributions – for higher rate taxpayers but reduces to as little as £10,000 for additional rate taxpayers.
For those who still have surplus income they want to shovel into a tax-free savings home – and are already fully using ISAs – an enterprise investment scheme is a viable option.
Experts say the investment vehicles are attractive because they give investors access to innovative companies at an early stage in their development. Businesses that sometimes can grow faster than companies listed on the stock market – but equally have a greater propensity to fail or to disappoint.
If you don’t believe me, just look at the troubles Neil Woodford has experienced as manager of Patient Capital, an investment trust investing in the same kind of embryonic businesses that enterprise investment schemes look at. The trust’s share price is down more than 40 per cent in just over four years.
Bright ideas: The schemes often invest in firms focused on environmental innovation
Figures from Revenue & Customs indicate that £20 billion has been ploughed into companies through these tax-friendly schemes since they were launched 16 years ago. A mix of retailers, tech firms, waste management companies, biotech specialists and the film industry.
Companies that enterprise investment schemes are allowed to back are usually fledgling businesses – typically no more than seven years old – and they must employ fewer than 250 people and be valued at less than £15 million. Investors’ cash has to be used to help grow and develop the business, not for buying out a founder, for example.
Should you take a punt on these?
Foresight Williams technology EIS – a link-up between venture capital trust manager Foresight and the advanced engineering division of the Williams Formula 1 team. These are higher risk, earlier stage innovative technology-focused companies.
Earthworm EIS – environment focused with a bias towards infrastructure and processing organic waste.
Parkwalk Opportunities – focused on early-stage innovative companies that are using intellectual property and technology spun out from Britain’s universities.
Ben Yearsley, director of wealth manager Shore Financial Planning, is a fan of the schemes – but only for experienced investors. He says: ‘The best can offer significant returns on your investment, but it’s finding them that’s key.’
One of the big attractions is that they are tax efficient – a necessary carrot if the Government wants individuals to back some of Britain’s most exciting (but risky) start-up businesses. Investors receive 30 per cent income tax relief up front on up to £2 million invested in any one tax year. The investment must be held for three years to qualify for this perk.
There is also inheritance tax protection – which means that as long as you hold the investment for at least two years, the scheme should not form part of your estate for tax purposes.
Jason Hollands, of wealth manager Tilney, says: ‘Wealthy individuals who are heading for a big inheritance tax bill could use a portfolio of enterprise investment schemes to mitigate the cost.’
Capital gains from investing in such plans – if there are any – are tax free. Also, if you have made gains elsewhere – for example, from selling shares – any tax can be deferred by reinvesting the proceeds in an enterprise investment scheme. If it all goes wrong and the scheme fails, any losses can be used against income or other capital gains.
In the last tax year alone, more than £1.9 billion was raised for companies under the scheme. Hollands says: ‘Pensions have traditionally been the key way to reduce income tax. But because of the lifetime allowance and a reduction in the annual allowance for additional rate taxpayers, many are turning to enterprise investment schemes.’
Venture capital trusts are also an option, says Hollands, providing similar tax relief on investments – and both tax-free capital gains and dividends.
Those who invest in enterprise investment schemes need to seek advice and purchase them through a wealth manager or financial adviser. The minimum investment is often as high as £10,000 – more if the manager of the scheme invests in a series of eligible companies.
There is also a sibling of the enterprise investment scheme to consider – the seed enterprise investment scheme. These have helped raise more than £1 billion since launching in 2012.
They are considered even riskier investments because money is invested in pure start-ups. The scheme allows up to £100,000 to be invested and qualifies investors for even more generous income tax relief of 50 per cent.
There are options to get a piece of the action at a lower level of commitment. Tom Selby, of broker AJ Bell, says: ‘The rise of crowdfunding websites such as Seedrs and Crowdcube makes it easy for those with small amounts to dip their toes into the world of backing start-ups.’
Currently, it is possible to invest as little as £10 in some companies. For example, Watney’s Beer Company (a brewer that’s brought back the vintage Watney’s brand that disappeared in the 1980s) is enterprise investment scheme eligible and raising £400,000 on Seedrs. Money management app Money Dashboard is raising cash on Crowdcube.
So far, so irresistible. But the fact that both enterprise investment schemes and their seed equivalents invest in unquoted companies means it is not easy to cash in your money when you need it.
Neither are they a home for income investors as the companies involved do not pay dividends because they are going for growth. It is also an expensive form of investment with up-front fees of around 5 per cent and annual fees of up to 3 per cent.