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John Spiers: The trouble with tax shelters

by John Spiers on Jun 19, 2014 at 15:15

If you do decide to invest, then be prepared for some disappointments. Fortunately, EIS tax reliefs provide a useful additional layer of protection in the case of unsuccessful investments in the form of loss relief. You can do rather well by backing a load of EIS losers and a handful of winners.

The Seed EIS offers even more generous terms, including a 50% upfront tax rebate regardless of your marginal tax rate – but the risk level here will be even higher.

VCTs offer much more diversified risk. Some of the original backers, such as Baronsmead and Northern, have stuck to their well-tested policy of providing development capital to established businesses and have produced good returns.

Others have attempted to produce a low risk, asset-backed vehicle, relying on tax relief to generate most of the return. These seem to have just about delivered, but whenever they have an investment that goes wrong there is not enough growth potential in the rest of the portfolio to repair the damage.

An unfortunate feature of the VCT market is it has become a closed shop. The fixed costs associated with promoting and running VCTs are so high that you have to raise at least £8 million to be viable (and even that is marginal). The existing managers have the market to themselves, which is never an ideal scenario. 

Tax changes 

The latest tax changes seem pretty logical from my viewpoint as a taxpayer. The ruse whereby you could sell your shares in a VCT after the end of the qualifying period and buy new shares in the new trust for about 5% more – trousering a 30% tax rebate on the way – was unnecessarily generous, since many of those shareholders would have stayed on board anyway to enjoy the tax-free income (or avoid selling out at a large discount).

So will VCTs still be attractive under these rules? As I see it, more than half of the 30% tax rebate is wiped out by initial costs, the discount on NAV when you come to sell (and that’s taking the best case of 5% discount) and the high running costs compared with other collectives. So half of the initial tax relief is lost in the friction of the transaction and the rest is the compensation for the likelihood of sub-par returns.

 Where VCTs can really score is in the generation of a regular tax-free income, since that is so hard to find elsewhere.

 John Spiers was the founder of Bestinvest.

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