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Brexit – Tax efficiency in turbulent times.

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Capital is at risk. Tax planning and EIS tax relief depend on individual circumstances and are subject to change. Oxford Capital is unable to offer financial or tax advice and this blog should not be construed as such advice. This financial promotion has been approved and issued by Oxford Capital Partners LLP, which is authorised and regulated by the Financial Conduct Authority (firm reference no. 585981).

Typically, January represents the turning point of the financial year as clients become spurred by the familiar April year-end deadline. However, the twist this year comes in the form of our scheduled departure from the EU on 29 March.

Consequently, the economic uncertainty has led many to defer investments pending a resolution between the UK and our European counterparts. This suggest the next two months will see a flurry of repressed activity as clients use their remaining ISA and pension allowances.

But what next?

Alternative investments into unquoted companies are usually seen as an acquired taste given the need for investors with the commensurate risk appetite. Indeed, this is why in most cases such investments come with attractive tax reliefs.

EI-Yes investing

Legislation has consistently been strengthened as the Government recognises the fundamental role Enterprise Investment Scheme (EIS) plays in the wider economy. No fewer than 99% of all businesses in the UK are SMEs, accounting for 60% of all employment[1]. This not only speaks to the importance of small businesses, but also the scope of opportunities when sourcing investee companies.

Furthermore, these companies tend to be better prepared to weather an uncertain economic climate. By definition, they need to be small, agile and able to adapt quickly as they grow from niche markets.

The EIS sector has come a long way in the twenty years since its inception. As it becomes more mature, we are seeing the emergence of serial entrepreneurs benefiting from a dynamic ecosystem of collaboration and support from VC funds, accelerators and a liberal regulatory regime. Indeed, experience has shown that the vast majority of big exits came from repeat founders.

Another sign of a maturing sector is the role of larger institutional investors. The Government is encouraging pension funds and market leaders to work together and pool investment with the British Business Bank into patient capital. With total assets expected to reach £1 trillion by 2025[2], this could really help those successful companies that eventually outgrow EIS funding.

IHT planning needn’t be taxing

For those that find the prospect of EIS qualifying investments too risky, structured Business Relief (BR) could provide a useful alternative.

Typically, unquoted companies in this area have tended to invest across renewable energy and property assets. This is usually undertaken through a combination of direct investments and secured loans. There are several reasons this is attractive.

While Government support for new green projects has tapered away, existing subsidies will commonly have 15-20 years left to run. This has the effect of underwriting a significant portion of the revenues earned by companies. Better still, they are also index linked.

The fundamentals driving the property market also remain strong. While there was a modest decrease in London, the Halifax House Price Index shows the average price of UK houses increased by 1.3% in 2018[3].

There continues to be a well-documented shortage of affordable residential accommodation. The Government estimates between 240,000-250,000 new homes are needed to keep pace with household formation. In 2016/17 total housing stock increased by 217,000, an increase of 15% on the previous year[4]. A step in the right direction but still plenty of work to do.

The demand for alternative finance has also been fuelled by a big drop in bank lending. In 2008, UK high street banks provided 72% of financing. By 2017 this figure had fallen to 47%[5]. While a disorderly Brexit may hit house prices, conservative LTV terms can give significant headroom before a drop would begin to affect investor returns.

Returns for these investments can vary but it is common to see targets of 3-5% with the top performing fund managers posting net returns of 5%+. These investments can also be used to generate a regular income. And this is without accounting for the 40% IHT saving after shares have been held for two years. Should these shares subsequently be sold, the proceeds can be reinvested within three years to obtain immediate IHT exemption.

What does this mean for ‘EU’?

All of this is to say despite the uncertainty, the UK retains a competitive advantage in the tech space. Coupled with strong regulatory support and a budding ecosystem, there are plenty of opportunities for VC managers to assess.

Separately, BR enables clients to access investments in unquoted companies offering stable, inflation beating returns. When structured correctly, they can include natural hedges against some of the possible outcomes of a disorderly Brexit.

In short, tax efficiency isn’t limited to ISA and pension contributions. While it may be impossible to fully insulate clients from prevailing market uncertainty, alternative investments present a great opportunity to diversify portfolios while taking advantage of further tax reliefs.

[1] EISA, 2015

[2] UK Defined Contribution: Looking Beyond the Passive Approach, Spence Johnson Market Intelligence, 2016 (available at: http://www.spencejohnson.com/products/market-intelligence/retirement/18/uk-dc)

[3] Halifax House price Index, 2019 (available at: https://static.halifax.co.uk/assets/pdf/mortgages/pdf/December-2018-House-Price-Index.pdf)

[4] House of Commons briefing paper, ‘Tackling the under-supply of housing in England’, December 2018 (available at: https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=2ahUKEwjh37HL-6ngAhUERhUIHXM0D6wQFjAAegQIChAC&url=http%3A%2F%2Fresearchbriefings.files.parliament.uk%2Fdocuments%2FCBP-7671%2FCBP-7671.pdf&usg=AOvVaw3KP2BFGcb7I20rR2aUesQx)

[5] De Montfort Year-end 2016 commercial Property lending report

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