The ‘SEISmic’ Shift Going Almost Unnoticed
- On February 28, 2017
- By Kate Arnold
The power of seed investing and its hugely generous tax reliefs are not being fully exploited by advisers – and clients could be missing out, argues Tom Hopkins
If you had a suitable client who might be interested in probably the most generous, government approved, tax break in the world, would you know what it is? It seems few advisers do because – unlike its big brother the Enterprise Investment Scheme (EIS) – they have certainly not yet not fully embraced the Seed EIS or ‘SEIS’.
Perhaps it is understandable, given the SEIS tax break is relatively new but, still, the unique scheme is coming up for its fifth anniversary and increasingly investors are getting used to the mechanics – just like EIS – and the various strategies it offers.
It is beginning to show that SEIS has been a great driver for the UK economy by helping start thousands of businesses and help projects get off the ground. In 2014/15 – the most recent year of available official statistics – 2,290 companies received investment through SEIS and £175m of funds were raised (versus £1.8bn for EIS). That is great, of course, but the question you ask, quite rightly, is – how risky is SEIS?
Given the company needs to be less than two years old and have gross assets of less than £150,000 to qualify for SEIS, by definition it is categorised as ‘high risk’. But, as with EIS, there are varying degrees of risk depending on strategy. And while a third of the £175m raised in 2014/15 went to technology companies, SEIS has been used to fund everything from entertainment projects through to planning consents.
Furthermore, the tax breaks significantly reduce overall risk. As well as the headline 50% initial income tax relief, there is capital gain tax (CGT) write-off and loss relief available so, for some investors, they are risking as little as 13.5p per £1 invested. In essence this means that, in real terms, even in the worst-case scenario, they will receive back 86.5p for every £1 invested – and what other investment vehicle can promise that?
With the investment limit per company of £150,000 and an investor cap of £100,000 per year – although an investor can use any unused allowance from last year so, potentially £200,000 – the amounts may be relatively small and yet, with these tax reliefs available, it can be worth the trouble.
Let’s take the example of John, a successful private equity fund manager. Luckily for John, his performance fees – or carried interest – are paid under the CGT rules and so he only pays 28% on a portion of his income. Although he is disappointed George Osborne classed carried interest payments alongside residential property – and so kept them at a 28% CGT rate and not the reduced 20% (or 10%) rate for other asset gains – under SEIS, he can make this ‘wrong decision’ right and reduce the CGT rate by half to 14%.
John earns £500,000 per year and received a £500,000 carried interest payment in the summer of 2015. John did not make any SEIS investments in 2015/16 so decides to invest £100,000 into SEIS companies in March 2017 in order to carry back to 2015/16.
In terms of income tax relief, John will receive a £50,000 repayment from HMRC for 2015/16 income tax already paid as he can carry back to last tax year. In addition he will receive a repayment of £14,000 on CGT already paid for 2015/16. Out of the £100,000 invested, therefore, he will receive £64,000 back from the government almost immediately.
Now, John understands risk and does not want to lose his money but the power of SEIS reliefs combined will reduce that possibility. Even if 50% of the companies fail and the remaining 50% just return his initial capital, say, then the net result is £122,250 from the £100,000 invested. With a 20% failure rate and average growth in the remaining portfolio of 25% on investment, the return quickly jumps to £168,500.
CGT Deferral Opportunities
The recent changes to the CGT rules have also resulted in more investors and their financial advisers focusing on historical CGT payments and combining SEIS with EIS CGT deferral opportunities. For instance, £100,000 into SEIS and £100,000 into EIS could result in a CGT bill reduced from £56,000 to £34,000 – or £14,000 if a client keeps deferring the CGT via EIS investment.
Nevertheless, the fantastically generous tax-efficiencies in this scheme generally remain underused. And we have to wonder why given the government is underwriting up to 86.5% of the investment …
Tom Hopkins is a co-founder and partner of Kin Capital, which provides fund-raising and fund management services to funds operating in government tax-efficient schemes
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