Wealthy investors turn to tax-efficient investments as new tax increases loom

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Wealthy investors are set to invest more into tax-efficient schemes such as Venture Capital Trusts (VCTs), the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) as a result of new tax increases coming in next month, according to a survey of 1,300 high-net-worth investors who are members of Wealth Club. Over two-thirds of investors plan to invest more, with just 5% expecting to invest less.

The new tax rules will apply from 6th April 2023 and will result in higher earners being hit with a series of punitive tax changes. These include a reduction of the additional rate tax threshold from £150,000 to £125,140, the Capital Gains Tax allowance dropping from £12,300 to £6,000 (and to £3,000 in 2024) and a reduction of Dividend tax-free allowance from £2,000 to £1,000 (and then £500 from 2024).

Despite the onerous tax increases, investors still see tax incentives as the main driver behind the success of the three venture capital schemes in the UK, with 56.4% of respondents planning to invest in VCTs, 26.78% in EIS and 14% in SEIS.

Alex Davies, CEO of Wealth Club, the UK’s largest broker of VCTs, EIS and SEIS, said that the next few years are likely to be bumper years for the three schemes as investors look to shield some of their hard-earned money from what is arguably the harshest tax environment since the 1970s. While the tax rises are bad news for investors’ pockets, there is at least a silver lining for UK PLC, as two-thirds of investors increasing their contributions as a result of more restrictive tax changes will deliver a massive cash injection to British start-ups, which is great news for jobs and economic growth. Currently, around £2.5 billion is being pumped into VCTs, EIS and SEIS annually.

Venture capital schemes such as VCTs, EIS and SEIS offer a highly tax-efficient way for more experienced investors to invest for their future. When investors invest in these schemes, they get income tax relief of between 30% (VCTs and EIS) and 50% (SEIS), and returns are also tax-free. However, it’s not just about the tax relief. Through these schemes, investors can access young, fast-growing, entrepreneurial companies that have the potential to offer high returns, as well as acting as a diversifier to a mainstream portfolio of funds and shares.

VCTs offer up to 30% income tax relief, and returns are paid through regular tax-free dividends, with an allowance of up to £200,000 a year. EIS investments also offer up to 30% income tax relief, with no tax-free dividends, but investors can defer chargeable capital gains they’ve realised. Investors can forget about the CGT bill for as long as they stay invested in any EIS, and it will only become payable once they come out of the EIS, unless they reinvest the money into another. The allowance for EIS is a whopping £1 million a year, or £2 million if investors invest at least £1 million into “knowledge-intensive” companies.

The Seed Enterprise Investment Scheme (SEIS) is the real winner when it comes to tax savings. Investors can cut both their income and capital gains tax in half when they invest. The allowance for SEIS is a more modest but still generous £100,000. A £100,000 investment could save investors up to £50,000 income tax plus £14,000 capital gains tax.

In recent years, the popularity of these tax-efficient investments has grown significantly. In 2019/2020, HMRC reported that over £4.5 billion was invested in EIS alone, up from £1.6 billion just five years prior.

While the tax benefits are certainly a draw for investors, it’s important to note that these types of investments also come with a higher level of risk. Start-up companies are inherently more risky than established businesses, and it’s not uncommon for investments in these ventures to fail.

That being said, for investors who are willing to take on a bit more risk, VCTs, EIS, and SEIS can offer a unique opportunity to support emerging companies while also potentially receiving tax benefits.

With the new tax changes set to take effect in just a few weeks, it’s clear that many high-net-worth investors are looking to take advantage of these tax-efficient investment options. While it remains to be seen exactly how much money will be injected into start-ups as a result, it’s safe to say that the future is looking bright for these innovative young companies.