The following article was originally published in IFA Magazine on 31st January 2014:
Mark Payton, Managing Director at Mercia Fund Management, worries about the spirit and the enforcement of the EIS scheme:
The government announced that the Enterprise Investment Scheme has generated over £1.02bn in investment in the year to the end of March 2012, close to double the figure from the previous year. The question however is: where has this capital been invested?
A significant portion of this EIS capital has been allocated to schemes focusing on a capital preservation-led investment strategy, often through infrastructure based investments which may hold secured income streams. Two primary issues come to mind here: is the investment risk as low as the marketing suggests? And, is the scheme or fund in the ‘spirit’ of the relief, and therefore could fall victim of the recently introduced ‘subjective test’?
A key staple of the ‘capital preservation’ sector has been investment into renewable energy due to the secured income streams available on certain assets. However, removal or reduction in the relief available can lead to a substantial write down in the capital value of the asset, thereby reducing return and potentially leading to a loss on investment.
EIS schemes or funds targeting a low return, for example of £1.05-£1.20 on a £1 investment over 3-5 years, would suggest a low risk, low volatility investment. However if these products fail the subjective test, then not only is the tax relief lost driving the return on investment – the investor will also find themselves having to repay their tax reliefs acquired to date; with an asset of significant value than originally envisaged, and they will of course lose any loss relief available to that investment
The focus on capital preservation within the tax efficient investment sector is understandable, given the economic climate and regulatory pressures faced by advisors. However, the tide is beginning to turn as a result of sluggish performance from many such schemes alongside increased HMRC scrutiny, of which many expect products to fall foul of the subjective test.
Mark Payton, Managing Director at Mercia Fund Management, comments:
“At their heart, EIS & Seed EIS reliefs are designed with capital growth in mind, rewarding the risk taken by investing into earlier stage businesses through both the enhancement of investment returns and importantly the reduction in associated capital risk through the availability of loss relief on qualifying investments.”
“In contrast, capital preservation schemes primarily focus on return via tax relief and largely ignore the advantageous additional reliefs available, thereby limiting the benefits to investors.”
“Mercia Growth Fund 3 provides an alternative to mainstream tax efficient investments, targeting annual compound growth of 10-50% (excluding tax advantages) through supporting stellar opportunities in UK technology led businesses that have met strict investment criteria and have also been approved by an external, independent investment panel.”
“The Fund is designed to offer investors the real prospect of significant capital growth before any tax benefits are applied whilst hedging risk through investing across a portfolio of high growth businesses, led by an experienced and sector specialist investment team providing investors with substantial tax-relief benefits garnered from both SEIS and EIS. In addition, the associated capital risk to investors is considerably mitigated through the availability of loss relief against individual investments within the portfolio, whilst returns can be enhanced through both the initial uplift available alongside the tax exemption on capital gains (assuming qualifying investments are held for a minimum of 3 years).”
Posted by Michael Wilson, in IFA Magazine.