Budgeting for change

This year''s budget saw the chancellor make surprise changes to EIS and VCT rules. As well as sounding the death knell for Aim VCTs, these changes also impact the risk profile of this type of investment. With demand already weakening following the cuts in tax benefits, can these tax shelters survive this latest swath of governmental tinkering?

The first change is a restriction on the amount of employees in investee companies. For all investments after April 5, the employees in EIS and VCT-funded companies will be limited to 50. While few VCT providers have yet determined the extent to which it will limit their investing universe, all agree that it will have an impact on the type of companies that VCT managers can back and the risk profile of the trusts will change. Matt Brown, Head of IFA Advisory Sales at Close Ventures, says that it will push VCTs towards smaller, earlier stage companies, which tend to carry more risk.

Patrick Reeve, Managing Director of Close Ventures, says: "This restriction seems to have come from pressure from the EU on state funding to target very small companies. It certainly makes life more complicated. Smaller companies are not necessarily higher risk, but they do require greater due diligence."

The Chancellor has also limited the venture capital funding available to individual companies. This has dropped to £2m. This prevents - as previously happened - VCTs clubbing together to invest in one company and means many companies will have to look elsewhere for funding.

Brown says that both these changes will have an impact on the types of company in which venture capital managers can invest. He adds: "Some are high tech, where the value lies in intellectual property rights. On the other hand, there might be some asset-backed businesses that are labour intensive - gym chains, for example.” He believes it will be the death knell for Aim VCTs as none will meet the employee restriction.

These changes have led to a rush to gather money before the fiscal year end. It has also led to plans for new VCTs and EISs being scrapped. Mark Stemp, partner designate at Chancery LLP, says: "These products were becoming less risky because people were putting together cleverer ideas. These changes take them right back to the risky side. The changes from the 2nd March have stopped demand for film partnerships. This stated that you couldn''t offset losses against other income."

Stemp says he used to use these schemes for basic and lower rate tax clients. For higher rate payers, he would look to Enterprise-owned syndicates of commercial buildings, which attracted tax relief at 100%. These tax reliefs are also being phased out over the next four years.

One beam of light in the Chancellor''s attack on tax shelters was the change to the reinvestment requirement. VCT managers now have six months to reinvest money from an investment. Previously, they had to meet the 70%-invested requirement at all times. Reeve says this is an advantage and will give him longer to find better opportunities.

But overall the picture is not rosy for tax shelters. The tax advantages still make for a reasonably sound investing case, but investors will be taking more risk. Stemp says that the availability of tax shelters has been reduced significantly. Having introduced many of these reliefs at the beginning of his tenure, it is clear that the Chancellor has had a change of heart.

1 Apr