The FSA’s explicit warning about Enterprise Investment Scheme (EIS) and Venture Capital Trust (VCT) financial promotions will do little to help financial advisers defend complaints about such investments if FOS makes a habit of disregarding their ‘preferential tax status’.

An increase in tax relief on and reforms of EIS and VCT investments, coupled with the resulting increase in interest from investors, has prompted a warning from the FSA as to how they are to be marketed.

The schemes offer the potential for generous tax relief but contain high levels of risk owing to the smaller sized companies in which the investments are made. For example, recent news reported on London’s Old Vic Productions which had successfully generated £1.24 million from a share issue courtesy of an EIS, but it has recorded a loss of £630,000 for the year to 2010.

The FSA’s recent warning stresses the obligation on firms to comply with their COBS duties (COBS 4.2.4(1) and 4.5.7(1)) and to ensure that they include prominent, clear warnings as to the inherent risk involved when promoting EIS and VCT products. The risk taken in pursuit of tax relief is made all the more great as its availability is dependent upon the invested company maintaining its qualifying status.

We have seen an example of the FOS refusing to acknowledge the ‘preferential tax status’ element of an investment when adjudicating a complaint. If one ignores the tax benefits, the risk of such investments will almost inevitably make them unsuitable.   The percentage tax benefit should be off-set against the percentage of any loss in value before the investment losses are assessed.

Although this may have been a one off, if the FOS has adopted a policy of assessing the suitability of such investments in their own right, relying on the tax risk warnings in the promotion will not be enough.  Let’s hope the FSA’s Industry Update accords with current thinking at FOS.