EIS and VCT Budget changes – “but what do they mean for my clients and me”?

In the first of three articles on the changes brought in with the Budget, James Ramsay, a tax efficient specialist, takes an adviser’s eye view of the changes and their implications to firms and their clients.

The details on the changes to the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCTs) from the Budget were announced at the end of November, the details on advance assurances came through in December as did the draft Risk to Capital condition. Royal Assent was then given on 15th March 2018, and the those change we are still awaiting the detail on will be back dated to then.

While the changes were not as radical as many Managers feared, the impact on firms that recommend these products and their clients is significant. With MIFID II to be considered too they will likely have to revisit how they recommend, administer, charge for and report on their EIS and VCT investments.

The way Treasury and HMRC want these investments to focus and operate has been made clear. Products that could deliver predictable allotments, timely exits and a degree of downside protection while still receiving advance assurance were highly sort after, but these have been specifically targeted with the new Risk to Capital Condition:

"The risk to capital condition is met if, having regard to all the circumstances existing at the time of the issue of the shares, it would be reasonable to conclude that —

(a) the issuing company has objectives to grow and develop its trade in the long-term, and

(b) there is a significant risk that there will be a loss of capital of an amount greater than the net investment return."

Our concerns for advisory firms and their clients on the back of this are:

Increased risk profile – meaning diversification will be more crucial than ever and client expectations will have to be managed.

Long-term holding periods  – meaning a longer ongoing monitoring and administration liability.

Less predictable allotment schedule  – (EIS) firms will have to track more, different allotment dates, trading dates and EIS3 certificates.

Less predictable exit schedule (EIS) – firms will have to track more varied exits and re-investment will be more complicated for replacement BR and CGT deferral.

Our perceived positives are:

No reduction in the initial tax relief – meaning EIS and VCT remain very attractive to clients and advisers.

Risk/ return profile – the expectation is that while more varied, average returns should be correlated to the higher level of risk being taken.

Preferable tax treatment (EIS) – EIS tax reliefs lend themselves even better to higher risk investments with the gains CGT free and losses covered by loss relief.

These present challenges for advisory firms, however with the implementation of appropriate processes and improvements in the client offering there is also a huge opportunity to differentiate a firm's proposition and to create further opportunities to add value to clients beyond their competitors.

In this first of three articles we will cover in brief: Increased Risk Profile of EIS & VCT Qualifying Companies; Capital Preservation - Last Chance Saloon...; Managing Client Expectations and Adding Diversification.

Increased risk profile of EIS & VCT qualifying companies

The most talked about point in the industry press around tax efficient investments has been the increased risk profile of EIS and VCTs after the new Risk to Capital test comes into effect at Royal Assent (RA). There is no doubt that HMRC wants to see a significant reduction in any inbuilt risk mitigation within the qualifying companies themselves. Most advisers were expecting this, but what are the implications?

Last Chance Saloon...

I for one was embarrassed by the way so much of our industry tried to rush advisers and investors into EIS/VCT ahead of the Budget. Many providers and promoters were also telling advisers RA was the last chance to get into capital preservation style EIS/VCT again. 

This time they were right. HMRC has given themselves a broad enough scope to reject anything that they feel looks like it has any aspect of capital preservation, without explanation. They have also instituted an ongoing test whereby they can re-check a qualifying company continues to trade in the manner it originally stated. These powers, combined with no advance assurances being allowed with capital preservation post 4th December, mean that Limited Life investments are finally making their exit.

Should you have rushed in? If you found a Manager you are already comfortable with, that had explicit advance assurance for all of their capacity, and had deals in place to allow an allotment before the 15th March, it couldn't be held against you. Shares allotted ahead of RA will not have be caught by the new Risk-to-Capital test.

That is all old news though - now is the time to starting thinking about putting in place an advice model that will be viable going forward.

Managing Client Expectations

If you are one of the advisers that decided before the Patient Capital Review to move to a Growth EIS only model then hats off to you. You are in a minority, but you were right. For the rest of you will have to change the way you think about EIS/VCT and the way you educate and advise your clients.

Historically many of you will have selected a few Managers that had track records, impressive teams, experience in their chosen specialisation and some compelling risk reduction built in. While none of us would ever use an EIS or VCT purely for tax planning, it is safe to say these had a lot of useful characteristics as a planning tool. You would most likely have taken your clients through the risk mitigation techniques the Mangers used and given them some detail on some historic trades.

Your client meetings are likely to go very differently now. The way in which you add value with your recommendation will have fundamentally changed. You are no longer seeking out the products with the best risk mitigation, but rather your advice will bring the risk mitigation. You will structure a portfolio approach to EIS/VCT investments, you will bring more diversification into play and you will bring your approach to EIS/VCT much more in line with the other parts of your advice offering.

There is also a lot to be done on managing client expectations around the investment experience (covered in the next article).

Adding Diversification

Diversification is an extremely well established form of risk mitigation, and one that HMRC will not penalise you for. You will only ever have recommended EIS and VCTs to clients who could afford to lock up the money and potentially lose all of it. Even when capital preservation was readily available, the unquoted company, liquidity and corporate governance risks meant it was only ever for the highest risk portion of a client’s total wealth. EIS and VCT are some of the most obvious candidates for more diversification you will find.

It is all good and well to say but most of us know we should always have been diversifying further, it just wasn't practical. The DD, administration and the reporting on any more than three products a year sends shivers down the spine. Clients investing over multiple years would often require 10 or more conversations with Managers and a day of collating information on certificates and exit expectations ahead of every meeting with that client. I will resist the urge to go into a sales pitch, but suffice to say there are Services like TEPS' and a number of excellent tax efficient Platforms that will now make this a much more manageable proposition.

You should consider it.