Discover how Venture Capital Trusts (VCTs) and the Enterprise Investment Scheme (EIS) can work together to create a powerful, tax-efficient venture capital portfolio.
Should VCT investors also be considering EIS?
The start of VCT season is an important date in the calendar for tax-efficient investors and their wealth management teams, and rightly so given the generous 30% income tax relief. Similarly to VCT, EIS is a vehicle providing exposure to venture capital investments, whilst at the same time offering generous tax reliefs. However, the similarities end there, and that’s why they can complement each other so well in a diversified portfolio.
VCT vs. EIS: The Key Differences
Venture Capital Trust (VCT)
An investment into a listed company that holds a diversified portfolio of early-stage businesses.
30% Income Tax Relief
On up to £200,000 per year (5-year holding period).
Tax-Free Growth
Capital gains are completely tax-free.
Tax-Free Dividends
A key attraction for income-seeking investors.
Enterprise Investment Scheme (EIS)
A direct investment into qualifying early-stage companies, with shares owned by you.
30% Income Tax Relief
On up to £2m per year (3-year holding period).
Tax-Free Growth
Capital gains are completely tax-free.
Multiple Powerful Reliefs
Includes CGT deferral, IHT relief, and valuable loss relief.
Uncapped Growth Potential
Direct ownership means a single winner can deliver significant returns.
What are the key differences between EIS and VCT?
A VCT investment provides access to a diversified portfolio of early-stage companies, whilst offering 30% income tax relief on up to £200,000 a year if held for 5 years, tax-free dividends and tax-free gains. In comparison, EIS investments allow 30% income tax relief on up to £2m a year with a minimum holding period of 3 years, and tax-free gains. In addition, EIS also offers CGT deferral for gains in the previous 3 or next 1 year, shares benefit from inheritance tax relief as business relief qualifying assets, and losses are eligible for loss relief at the investor’s marginal tax rate. The combination of income tax relief and loss relief means that an additional rate tax payer’s maximum exposure to loss is 38.5% of their investment.
A VCT is an investment into a listed asset whose value and dividends are determined by the performance of the underlying investee companies. With EIS, the investments are made directly into the companies and the shares are owned by the investor. This means that EIS investments are illiquid, but have uncapped growth potential, and a single big winner in a portfolio can make a significant difference to overall performance. Conversely, as VCTs are so well diversified, exposure to each underlying company can be very small and strong performance in individual companies can be diluted.
At a Glance: VCT vs. EIS
| Feature / Benefit | VCT | EIS |
|---|---|---|
| Annual Contribution Limit | £200,000 | £1,000,000 (up to £2m) |
| Tax Year Carry Back Option | No | Yes |
| Minimum Holding Period | 5 years | 3 years |
| Income Tax Relief | 30% | 30% |
| Tax-Free Capital Gains | Yes | Yes |
| Tax-Free Dividends | Yes | No |
| CGT Deferral Relief | No | Yes |
| IHT Relief | No | Yes (after 2 years) |
| Loss Relief | No | Yes |
A Powerful Partnership: EIS & VCT Working Together
Their differences in structure and benefits mean they can be used together to maximise tax efficiency and growth potential. Let’s consider a client at a 45% marginal tax rate who invests £100,000 in EIS and £100,000 in VCT.
Combined Portfolio Potential:
This strategy allows the VCT to provide steady, tax-free income while the EIS portfolio grows in value. Failed investments in the EIS portfolio benefit from loss relief, and as the VCT returns capital after 5 years, the EIS portfolio is gearing up for potentially significant tax-free exits. A program of regular investments could mean the tax relief alone eventually funds the entire strategy.
EIS and VCTs can complement each other well in a diversified portfolio as their differences in structure and tax benefits mean they can be used together to maximise tax efficiency and growth potential. Consider a client who pays a marginal tax rate of 45% and invests £100,000 in EIS and £100,000 in VCT at the same time with the following portfolio targets:
- EIS: target deployment time of 12 months, portfolio of 8 companies, target return of 2.5x subscription, exits 5-8 years after investment.
- VCT: dividend yield of 5%, target return of capital invested.
To demonstrate the potential for this strategy, let’s assume that the portfolios achieve all targets: the client can expect to benefit from income tax relief of £60,000 across both products within a year. The client can expect to benefit from tax free dividends of £5000 per year for 5 years from the VCT, whilst the EIS portfolio companies work to build value. Due to the high risk nature of the underlying investments, it is expected that some companies in each portfolio will fail, and those that fail in the EIS portfolio will benefit from loss relief at 45%. As the VCT winds down after 5 years and the capital of £100,000 is returned to the client, the EIS portfolio should start to gear up towards exiting the underlying companies. You would expect to see some variation in the value and timing of the returns, but a target of 2.5x means total tax-free distributions of £250,000 over years 5-8 of the strategy. If a suitable client were in a position to invest in this way every year, or even every 2 years, they could soon find that the accumulation of income tax relief alone could fund their investing, with uncapped, tax-free growth potential.
It is worth a mention that this example doesn’t bring CGT deferral or IHT relief into focus: a program of regular investments into EIS can provide a safety net for the deferral of any planned or unplanned taxable gains from other assets, for example from downsizing a property portfolio or rebalancing a GIA. Any deferred capital gains may be continually deferred by reinvesting, and are written off at the point of death. EIS investments can also benefit from inheritance tax relief provided they have been held for the two-year qualifying period.
It cannot be understated that both EIS and VCTs are high risk investments, therefore they are only suitable for clients with the appropriate level of wealth and appetite for risk. However for investors interested in tax mitigation, who wish to be exposed to venture capital or are already active VCT investors, EIS could be a valuable addition to their portfolio.