It’s that time of year again when investors are considering tax efficient investment strategies. Gaining popularity this year is the Enterprise Investment Scheme because of the increase in the income tax relief from 20% to 30%, making it compare very favourably against VCTs which don’t offer the same CGT reliefs and require a longer hold period before gains become capital gains free.
A comparison between EIS and VCT is the subject of another post but here we compare Unapproved and Approved EIS funds.
Firstly, Approved in this context means HMRC Approved. It does not mean that the fund is approved by anyone giving an opinion about the quality of the investments, investment team, investment strategy or anything in fact. It doesn’t even mean that the investments made by the fund are pre-approved as actually qualifying under the EIS. The only difference between an Approved and an Unapproved fund is that the Approved fund prospectus has been reviewed by HMRC and, provided the fund invests at least 90% of its assets in EIS qualifying investments within the 12 months following closing the fund, then investors in the fund will be treated as having made the EIS investments as at the date the fund closes and not, as is the case with an Unapproved fund, when the fund actually invests in the EIS investments. Apart from another minor difference – there being no £500 minimum investment in Approved EIS fund – that’s it.
If there was ever a case of the tax tail wagging the investment dog choosing one fund over another because it is Approved is it. In fact there are many good reasons to favour Unapproved over Approved. Leading publication Investors Chronicle summarises the point pretty well:
“From an investment perspective, an unapproved fund is potentially in a better position as it has longer to choose its investments and build a more diversified portfolio. This can mean approved funds spread their risk over fewer investments due to the time restriction.”
“An unapproved fund gets its income tax relief on the date of each investment, provided it qualifies. Ultimately, when choosing an EIS, you have to balance certainty of tax relief with the potential for better returns.”
http://www.investorschronicle.co.uk/2011/09/15/your-money/strategies-for-investing-in-eis-OfuoaIHVyvJ301AfQ7eMhL/article.html
Another reason to favour Unapproved over Approved is the flexibility over the use of the available income tax relief. Here’s an example:
An investor in an Approved EIS fund rushes to get their investment in before the 5 April 2012 deadline and makes a £100,000 investment. As it is an Approved fund he/she can claim 30% income tax relief against their 2011/12 income or, if they elect to treat some or all of the investment as having been made in the year ended 5 April 2011, only 20% income tax relief in that prior tax year. The investor won’t be able to claim any income tax relief in the tax year ended 5 April 2013 without making a new investment in an EIS in that tax year (or if the fund manager blows the Approved fund status).
If the investment is made in an Unapproved fund, either before or after the 5 April 2012 deadline (but obviously before the fund closes which it must do before the manager can invest from it) the position is different. Income tax relief is available following each investment by the manager so assuming the manager takes up to 2 years to invest the fund and manages the timing of investment so the fund is deployed equally over the 2 years, then the income tax relief is available across 3 tax years, all of which are at 30% (assuming no changes in the legislation applying to the year ended 5 April 2014).
Here’s an example with a £100,000 investment in an Unapproved fund which commences investment after 6 April 2012. If the fund is deployed equally over the two years ended 5 April 2013 and 2014 then the investor has the following options:
- Treat £50,000 as having been invested in the year ended 5 April 2012 giving income tax relief at 30%; and
- Treat £50,000 as having been made in the year ended 5 April 2013 giving income tax relief at 30%
Or
- Treat £50,000 as having been invested in the year ended 5 April 2012 giving income tax relief at 30%; and
- Treat £50,000 as having been made in the year ended 5 April 2014 giving income tax relief at 30%
Or
- Treat £50,000 as having been invested in the year ended 5 April 2013 giving income tax relief at 30%; and
- Treat £50,000 as having been made in the year ended 5 April 2014 giving income tax relief at 30%
Or
- Treat £100,000 as having been invested in the year ended 5 April 2013 giving income tax relief at 30%
Finally, as noted above an Approved fund must invest 90% of the total subscriptions in EIS qualifying companies within 12 months. Private company investments take a lot of due diligence and time with management prior to investment to get right so unless at fund closing there’s already a good pipeline of investments in place and on which the fund manager has been carrying out the necessary due diligence, that’s not a lot of time to source, win and diligence opportunities that merit investment, IMHO. YMMV.
This blog post is for information only and does not constitute investment or tax advice.
Enterprise Investment Scheme – Unapproved versus Approved
It’s that time of year again when investors are considering tax efficient investment strategies. Gaining popularity this year is the Enterprise Investment Scheme because of the increase in the income tax relief from 20% to 30%, making it compare very favourably against VCTs which don’t offer the same CGT reliefs and require a longer hold period before gains become capital gains free.
A comparison between EIS and VCT is the subject of another post but here we compare Unapproved and Approved EIS funds.
Firstly, Approved in this context means HMRC Approved. It does not mean that the fund is approved by anyone giving an opinion about the quality of the investments, investment team, investment strategy or anything in fact. It doesn’t even mean that the investments made by the fund are pre-approved as actually qualifying under the EIS. The only difference between an Approved and an Unapproved fund is that the Approved fund prospectus has been reviewed by HMRC and, provided the fund invests at least 90% of its assets in EIS qualifying investments within the 12 months following closing the fund, then investors in the fund will be treated as having made the EIS investments as at the date the fund closes and not, as is the case with an Unapproved fund, when the fund actually invests in the EIS investments. Apart from another minor difference – there being no £500 minimum investment in Approved EIS fund – that’s it.
If there was ever a case of the tax tail wagging the investment dog choosing one fund over another because it is Approved is it. In fact there are many good reasons to favour Unapproved over Approved. Leading publication Investors Chronicle summarises the point pretty well:
“From an investment perspective, an unapproved fund is potentially in a better position as it has longer to choose its investments and build a more diversified portfolio. This can mean approved funds spread their risk over fewer investments due to the time restriction.”
“An unapproved fund gets its income tax relief on the date of each investment, provided it qualifies. Ultimately, when choosing an EIS, you have to balance certainty of tax relief with the potential for better returns.”
http://www.investorschronicle.co.uk/2011/09/15/your-money/strategies-for-investing-in-eis-OfuoaIHVyvJ301AfQ7eMhL/article.html
Another reason to favour Unapproved over Approved is the flexibility over the use of the available income tax relief. Here’s an example:
An investor in an Approved EIS fund rushes to get their investment in before the 5 April 2012 deadline and makes a £100,000 investment. As it is an Approved fund he/she can claim 30% income tax relief against their 2011/12 income or, if they elect to treat some or all of the investment as having been made in the year ended 5 April 2011, only 20% income tax relief in that prior tax year. The investor won’t be able to claim any income tax relief in the tax year ended 5 April 2013 without making a new investment in an EIS in that tax year (or if the fund manager blows the Approved fund status).
If the investment is made in an Unapproved fund, either before or after the 5 April 2012 deadline (but obviously before the fund closes which it must do before the manager can invest from it) the position is different. Income tax relief is available following each investment by the manager so assuming the manager takes up to 2 years to invest the fund and manages the timing of investment so the fund is deployed equally over the 2 years, then the income tax relief is available across 3 tax years, all of which are at 30% (assuming no changes in the legislation applying to the year ended 5 April 2014).
Here’s an example with a £100,000 investment in an Unapproved fund which commences investment after 6 April 2012. If the fund is deployed equally over the two years ended 5 April 2013 and 2014 then the investor has the following options:
Or
Or
Or
Finally, as noted above an Approved fund must invest 90% of the total subscriptions in EIS qualifying companies within 12 months. Private company investments take a lot of due diligence and time with management prior to investment to get right so unless at fund closing there’s already a good pipeline of investments in place and on which the fund manager has been carrying out the necessary due diligence, that’s not a lot of time to source, win and diligence opportunities that merit investment, IMHO. YMMV.
This blog post is for information only and does not constitute investment or tax advice.
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