Deep pocket brigade

PEOPLE with serious cash to invest and no fear of risk may find that a new generation of tax-efficient investments make a useful contribution to protecting their money from tax.

The Enterprise Investment Scheme (EIS), and latterly the Venture Capital Trust (VCT), have been introduced as replacements for the popular Business Expansion Scheme. Both schemes offer tax breaks to investors who are prepared to stake their money in developing business opportunities. You can invest up to pounds 100,000 in both, each tax year.

But neither are suitable for people who cannot afford to lose their money. Ian Millward, of Chase de Vere, independent financial advisers in Bath, says: "Some people talk about failure rates of 60 to 70 per cent for the company holdings in VCTs. They are really only for the very sophisticated investor."

Likewise, Paul Boni of Berry Birch & Noble, independent financial advisers in London, is dubious about the supposed benefits of EIS investments. "We have used this investment, but frankly it is one which we are waiting to become more attractive." With an EIS you invest in just one trading company, while VCTs offer a portfolio of holdings in other small companies.

Both schemes offer the carrot of 20 per cent income tax relief on money you put in, and as with personal equity plans, all profits are tax-free (although you must keep your shares for at least five years to benefit).

But EISs and VCTs provide most benefit to people who already have significant capital gains. The gains can be rolled over into an EIS or VCT, delaying the payment of any capital gains tax due. When the investment is finally encashed, the investor still has to pay the original CGT bill but he does not have to pay any CGT on gains made with the money in the meantime.

For example, if an investor made a capital gain of pounds 10,000 on some shares he might face a tax bill of pounds 1,000 in tax (40 per cent on pounds 4,000, assuming he has not used up his pounds 6,000 a year capital gains tax-free allowance elsewhere. The example also ignores the indexation concession - which is that only gains above inflation are liable for tax). But say that pounds 10,000 was rolled over into an EIS and grew to pounds 15,000. Normally (with pounds 6,000 of those gains tax-free) the investor might face a tax bill of up to pounds 3,600 (40 per cent of pounds 9,000) but because the gains were made by investing in an EIS he would still only be facing the original pounds 1,000 tax liability. This deferral extends to gains realised up to a year previously for both VCTs and EISs.

VCTs are likely to prove more tempting in the long run for private investors. These trusts have a basic structure very similar to that of investment trust companies. In addition, they must invest no more than 15 per cent of their assets or pounds 1m, whichever is the lower, in unquoted companies with a capitalisation of up to pounds 10m. In practice this means that many trusts will invest in up to 25 different companies.

Martin Mullany, of Brooks Macdonald Gayer, the independent financial advisers, says: "Although the trust is high-risk, because it is investing in unproven companies, the risk is diluted by investing in a range of such ventures. In comparison, investors in an EIS are risking their money on just one company."