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Wealthy investors flock to start-ups for tax breaks amid looming capital gains tax raid

September 30, 2024

Wealthy investors are increasingly turning to start-up companies to mitigate their tax burdens, particularly as a potential capital gains tax (CGT) increase looms in the upcoming budget.

Investment in seed enterprise investment schemes (SEISs) surged by 250% between July 4 and September 16 this year, according to Wealth Club, with savers hoping to reduce their CGT liabilities by up to 50%.

The spike in SEIS investments coincides with government efforts to stimulate economic growth by encouraging investment in small British businesses. SEISs allow investors to put up to £200,000 annually into early-stage firms, providing significant tax advantages, including 50% income tax relief and exemption from CGT on any gains made from the investment. Crucially, they also offer 50% relief on CGT from the sale of other assets, such as buy-to-let properties, when reinvested in qualifying SEIS companies.

With CGT reform expected in the budget, investors are seizing the opportunity to benefit from the extended SEIS tax breaks, which were recently prolonged until 2035. A higher-rate taxpayer who reinvests a £100,000 gain into an SEIS fund could reduce their CGT bill from £24,000 to £12,000, while also securing £50,000 in income tax relief.

Nicholas Hyett of Wealth Club points out that high-net-worth individuals are increasingly using SEISs to shelter future gains from tax, given the likelihood of changes to CGT, inheritance tax, and pensions. “It’s no wonder wealthy investors are taking advantage of schemes that provide upfront tax relief while protecting future gains,” Hyett says.

However, SEIS investments carry considerable risk. While the tax benefits are designed to compensate for the high risk of backing start-ups, investors should be aware that around half of SEIS companies fail within five years. Nonetheless, successful start-ups like Swytch Bike, snack company Olly’s, and food supplement maker Hunter & Gather highlight the potential rewards.

In contrast, enterprise investment schemes (EISs) and venture capital trusts (VCTs) offer less generous tax relief, though they remain popular with wealthier investors. EISs allow for up to £1 million in annual investments with 30% income tax relief and deferred CGT, while VCTs provide tax-free dividends and CGT exemption, with investments managed through a fund to help spread risk.

These schemes are not for the risk-averse and should form only a small portion of a wider, more mainstream investment portfolio, experts advise. Jason Hollands of Evelyn Partners warns that while the minimum holding periods for tax relief are set at three years, exits from these private companies depend on finding a buyer, which is not guaranteed.

Despite the potential for high rewards, investors are also urged to consider the higher charges associated with SEIS funds. Fees can include an initial charge of 2.5%, along with management and performance fees that may add up over time. Investors need to carefully assess the risks and rewards before diving into these niche, high-risk schemes, where tax advantages alone should not drive decision-making.