An even break for savers who support small firms

SINCE the demise of the Business Expansion Scheme (BES), which was killed off at the end of 1993, the Government has been introducing new tax incentives to encourage private investors to back small companies.

First was the launch of the Enterprise Investment Scheme (EIS) in January 1994, and this was followed last April by the arrival of Venture Capital Trusts (VCTs) - in the wake of Kenneth Clarke's November 1994 Budget.

The idea behind both these developments is to make the high risks of backing "boom-or-bust" venture capital investment more palatable by offering attractive tax breaks to private investors. These are tax relief; no tax on income paid out or growth of your investment; and the ability to defer existing tax liabilities on other investments.

The EIS was a variation on the old BES theme. EIS investments offer tax relief on investments up to pounds 100,000 in specified qualifying trading companies, and there is no capital gains tax on the proceeds provided the shares are held for at least five years.

VCTs are quoted investment trusts which have to invest predominantly in the unquoted shares of qualifying unquoted trading companies. In practice this means that at least 70 per cent of a VCT's portfolio has to be invested in such companies within three years of their launch, although the remainder of the portfolio may be put into blue-chip shares, to lessen the overall risk. VCTs attract similar income tax and capital gains tax relief to that allowed on EIS investments.

The three years are allowed because investing in companies of a suitable quality can be a lengthy process. The question of exactly what constitutes a qualifying unquoted trading company can be quite complex. The crucial thing is that they should be "trading" companies, actively carrying out business.

Property companies of the type that came to dominate the BES market are excluded, and the maximum amount that any one company can receive via an EIS or VCT investment is pounds 1m.

In the case of EIS investments, there will usually be an offer period of several weeks, during which investors can buy shares in a particular company or fund. After this period, investors are locked in for five years to secure EIS tax relief.

With VCTs the picture is slightly different, since these have been deliberately structured as quoted investment trusts to ensure there is a market in their shares. VCTs tend to be managed by companies with an established track record in the venture capital field with launches capped at between pounds 15m and pounds 30m, because of the limit of pounds 1m per company.

Major launches over the past few months have included VCTs managed by Murray Johnstone, Baronsmead, Friends Provident and Northern Venture Managers. February will see a string of launches from Hodgson Martin, Advent and a joint launch by Yorkshire Fund Managers and specialist management house Equity Ventures.

In practice there are limits to the tax breaks. Upfront income tax relief is set at 20 per cent, whatever your own tax status. You can invest up to pounds 100,000 a year in either VCTs or EISs. The ability to defer tax only relates to existing capital gains on other investments.