In the heated climate of debate about tax avoidance, it is easy to forget that some forms of avoidance are entirely legitimate, and encouraged by governments.

The tax-efficient structure in the UK known as the Enterprise Investment Scheme, launched by the John Major administration in 1994, has proven durable, surviving Labour and other governments. At a time when politicians – not always wisely – are reducing some tax-advantaged savings, EIS structures remain a beacon. This publication has been told that since EIS tax benefits and investment freedoms were enhanced a few years ago, entities such as family offices among others have become interested in the EIS model. This article, by John Glencross, founder of Calculus Capital, an award-winning firm operating in the space, addresses the heated debate about the need to distinguish legitimate from not-so-legitimate tax avoidance. As ever, the views expressed here are not necessarily shared by this publication’s editors but we are pleased to share these insights. We invite readers to respond.

With only a few months to go until the UK general election and with the main political parties now well into the swing of what will surely be the most closely-fought campaign in many a year, it’s unsurprising that the pre-election pitches have started and that hopeful vote-winning promises are beginning to be dangled in front of us. Indeed, with the Conservatives already having reheated and re-served their offer of a substantial raise in the inheritance tax threshold, it’s a neat demonstration of Benjamin Franklin’s truism that there are only two things certain in life: death and taxes.

Whilst the election might well be fought and won on the twin issues of economic competence in the face of a challenging European context and stewardship of the health service, a notable feature will be the main parties’ offers when it comes to tax. Notwithstanding fighting over credit for the rise in the personal allowance, or claims and counter-claims of “tax bombshells”, it will be interesting to see what promises are made regarding that perennial issue: tax avoidance.

Closing tax loopholes has long been a stated aim of successive UK governments – indeed there can be little political sport more likely to cheer the masses - and it can have come as little surprise to the likes of Amazon and Google when George Osborne, chancellor, finally moved to close a tax loophole in last year’s autumn statement [budget statement to parliament] allowing companies with substantial UK businesses to avoid paying corporation tax to the government, thus giving them an unfair competitive advantage in comparison to UK businesses. The move, which will come in to force in April, should raise the exchequer an estimated additional £1 billion ($1.54 billion), funds that are much-needed at a time when recovery in public finances is being hampered by lower-than-expected tax receipts.

Legitimate
However, while cracking down on schemes and behaviour designed specifically to avoid tax is something that should be applauded, there are certain types of legitimate tax incentives aimed at encouraging entrepreneurship that, when used appropriately, have been of massive benefit to the development of fledgling UK businesses, creating private sector jobs and eventually increasing tax revenues in the form of increased income tax and corporation tax.

The tax incentives provided to encourage investment in small- and medium-sized businesses have been paid for many times over through their role in underpinning growth and creating jobs. Small- and medium-sized businesses account for about half of UK private sector employment and one third of private sector GDP.

Incentivising private investors to place their money into young companies is especially important at the present time, given that banks, once a traditional source of start-up capital, are under increasing regulatory and capital restraints and have been more constrained in recent years on the lending front. Additionally, start-up companies can find the banking fees and interest prohibitively expensive.

Both the Enterprise Investment Scheme and Venture Capital Trusts, set up in and 1994 and 1995 respectively, have contributed greatly to the health of UK plc.  Since their inception thousands of companies have benefited from investments made through these schemes, and their attraction for investors is continuing to strengthen.

VCTs alone raised £393 million in the year to April 2014, an increase of 45 per cent on the funds raised in the previous year, with the sum invested into EIS’s touted to be far higher. Calculus Capital has been investing in small UK companies for over 15 years; we currently have £120 million under management, and an impressive track record of successful exits has ensured a loyal client base of repeat investors.
 
We have worked with Conservative, Labour and indeed the Coalition government to ensure that the rules around EIS and VCTs are both sufficiently robust to ensure that the schemes do not become tax avoidance vehicles, but are flexible enough to evolve with market and economic conditions and to remain attractive to private investors.

Bogus scheme alert
The UK government has been right to act against bogus schemes, such as some film financing, and most recently the autumn statement clarified that anaerobic digestion schemes and hydropower projects would be ineligible for EIS and VCT tax reliefs. This came as a response to a sudden increase in the marketing of such schemes by some advisors following the withdrawal of such tax breaks for wind and solar schemes, which are already subject to government help in the form of subsidies.

These changes should be welcomed by the EIS and VCT industry, as the Treasury’s actions show that the government is keen to keep to a central tenet – investors should be rewarded for taking what is essentially higher risk investment in legitimate small and unquoted companies.

Successful investment targeting by EIS and VCT managers can produce stellar, and importantly, tax-free, investment returns. Take the sale in December 2014 of Waterfall Services, a contract caterer that was founded at the beginning of the financial recession in 2007.

It has produced a gain for investors of £1.3 million on total sale price of £1.9 million – representing a return on investment of 5.3x (exclusive of tax reliefs). Funds provided by its backers, including Calculus Capital, helped the company to grow. In fact, when it was sold on to LDC in December, the company employed more than 2,800 people in the UK – an increase of 550 per cent since Calculus’s initial investment.

For companies in more sophisticated sectors such as life sciences, tax incentives to aid investment can be vital, as such sophisticated businesses are unlikely to attract the attention of traditional banking capital given their perceived complexity and risk profile.

A number of recent ground-breaking scientific developments, particularly in the field of diagnostics, have benefited from investments made through EIS and VCT. Take Calculus’s investment in Premaitha, for example, a company that has developed a non-invasive method for prenatal screening for chromosomal abnormalities such as Down’s syndrome.  Premaitha Health is run by an eminent scientist, Dr Stephen Little, with a proven track record in life sciences development and his company is an ideal recipient of investment that is tax incentivised to provide for the inherent risks in putting money in to a fledgling company in a highly innovative area.

The chairman of Premaitha Health is also on the board of Scancell, a life sciences company putting the UK at the forefront with its immunotherapy vaccines for the treatment of cancer. Calculus exited a portion of its holding in Scancell in April last year, delivering a return on investment of 8.2x to investors, showcasing that EIS benefits not only UK plc, but investors as well.  

As the election draws ever closer we are sure that the next government – whatever shade of blue, red, yellow or indeed purple it may be - will continue to endorse tax breaks to encourage investment in UK growth. But those in the EIS and VCT industries would be wise to heed elements of a saying by another eminent American: the price of freedom is eternal vigilance.