Brexit: VCTs, EIS and the future of tax breaks
With the fallout from Brexit set to rumble on for many years, it may be worth briefly considering what the impact on Venture Capital Trusts (VCTs) or Enterprise Investment Scheme (EIS) might be.
The first consideration is that there has been a raft of changes over the last few years, designed to fit in with EU state aid rules. Many VCT managers I have spoken to over the last few months have been frustrated by these changes and their implementation by HMRC. Therefore, in the long run, an exit could free up the government of the day to relax the rules and make these schemes even more attractive.
However, a note of caution should be mentioned before becoming too jubilant. Even if changes were mooted, they couldn’t be enacted until after the UK has left the EU as all the current rules still need to be abided by and Brussels has to approve any changes. That simply isn’t going to happen whilst an exit is being negotiated. Even post Brexit, if we want access to the single market some EU rules will probably still apply.
What is interesting though is that if there is malaise in the general economy, equity valuations might fall and banks might stop lending. Therefore VCTs currently sitting on cash (lots are after several good years for exits and fundraising) may have a great opportunity to make long-term investments at advantageous prices. Often the best returns are made when others are unwilling to invest.
Now to the important part, the impact on tax breaks.
Looking at the wider picture, the cost of VCT and EIS tax relief to the government is minimal. In the 2015/16 tax year £458 million was invested in VCTs. Assuming every investor received the full income tax rebate of 30%, this cost the exchequer £137 million. Last financial year the government (on our behalf) spent £772 billion, of which the VCT rebate only represents a minuscule percentage, 0.017%. That is insignificant when compared to the benefits VCTs and EIS bring to the economy. Indeed, in a recent survey 71% of companies receiving EIS or VCT funding stated they had grown employee numbers post the investment.
EIS was slightly more expensive, although the latest figures relate only to the 2014/15 tax year when £1.6 billion was invested. Again, assuming every investor received the full 30% income tax relief, the tax relief bill would have been £480 million plus the additional cost of lost capital gains tax after any deferrals. It’s reasonable to think the government has far more pressing matters to attend to than tinkering with these schemes.
I don’t think the tax breaks on offer will change in the short term. However, what is entirely possible is an increase in personal tax rates if economic conditions deteriorate in the UK. The immediate threat of an emergency budget has gone, but by the time a new prime minister is installed in the autumn the situation may have changed and tax increases may still be on the cards. If that is the case, using your tax efficient investment allowances could become even more crucial.
The managers' view
We've also asked asset managers to share their views with investors.
The attractions of investing in UK private companies remain strong. There is no sign of interest rates rising or, more widely, of returns on traditional assets returning to acceptable levels. Change creates opportunities and small companies can be more nimble in responding. Looking at the potential effects on Rockpool’s current investment pipeline, the portfolio and our investors, we think the impact will be modest. We will be discussing the potential effects with management at each of our investee companies and ensuring that their plans are flexed to deal with any challenges.Matt Taylor, Managing Partner at Rockpool Investments
It is business as usual for Downing. We recognise that there will be volatility in the markets but believe it will be reasonably short-lived and will provide opportunities for us. We will continue to fund small UK businesses with strong management teams and provide support to them as required over the coming months and years. We seek to build stable, long-term relationships with both management teams and our investors, meaning everyone's interests are aligned.Tony McGing, Partner & CEO at Downing
We are continuing to support UK SME’s; backing good management teams with clear strategies, whether they are looking to bring new products to market, expand overseas, or developing the range of goods and services they provide; and whilst we are seeing volatility in the equity and FX markets that will subside creating investment opportunities for our funds and trade opportunities for our portfolio companies.Andrew Ferguson, Partner at Maven Capital Partners
At Foresight, we don’t expect to see any further changes to the regulatory environment for VCTs and EISs while the process of exiting the EU is negotiated by the new Government team. With the ever increasing need to stimulate UK investment and growth, we believe VCTs and EISs will continue to play an important role in financing the growth of UK SMEs – depending on the eventual overall impact of Brexit, this role may well become even more important over time. However, in the short term we expect the current market volatility to favour infrastructure, an asset class which is uncorrelated to the market and traditionally seen alongside gold as a safe haven in times of volatility due in great part to its reliable, contracted, index-linked revenue streams. In this space, Foresight Solar & Infrastructure VCT “D” Shares, remains open for investment, targeting energy related infrastructure assets such as smart meters, with a target return growing to 5p per annum from year three. At the same time we would expect demand for our listed renewable energy infrastructure fund, Foresight Solar Fund Limited (Ticker : FSFL), to remain strong. FSFL currently offers investors an index-linked target dividend yield of 6.17p per share in 2016, which can of course be delivered tax free when held in a SIPP or ISA. If, as expected, interest rates come down, with the knock on impact on GILT yields, that could further increase the attractiveness of a 6.17% yield, which has built in protection against any inflationary pressures that might emerge due to the weaker currency from the index-linked ROC subsidy that applies. A weaker pound should have a positive impact on VCT portfolio companies which export to overseas markets. Foresight VCT “Ordinary” Shares Offer, which is currently open for investment, gives investors access to a mature portfolio of 27 unquoted trading companies, many of which are already profitable and enjoying strong growth.David Hughes, Chief Investment Officer at Foresight Group