A few weeks back I had an interesting conversation in the lawn bowls club — I freely admit to being a member, even though I’m in my 40s — with a person who owns his own business.

He was interested in venture capital trusts (VCTs) and the Enterprise Investment Scheme (EIS). These investments are the most interesting, risky and socially rewarding areas I get involved with on a day-to-day basis as an investment adviser.

Both are fundamentally private equity investments, and all bear the risks of private equity — with the bonus of tax efficiency. Investors must therefore bear in mind the essential caveats of tax suitability and personal circumstance, but also the old adage that you should never let the tax tail wag the investment dog. Are they backed by good, well-run companies that are likely to succeed?

VCTs and EIS are often held up as the natural alternative to pensions for high earners, because of the limitations of the annual allowance and lifetime allowance. Be in no doubt, though: neither are a replacement for a pension. The only thing they have in common with one is that all are in the financial services industry. Even when it comes to tax, they are very different. Pensions are based on a tax relief system and VCTs and EIS are tax reducers.

But the tax characteristics are worth discussing, since there are an impressive five advantages for EIS and three for VCT.

EIS is my favourite. First, there’s no capital gains tax (CGT) on disposal. Second, if you’ve realised a capital gain elsewhere you can roll the gain into an EIS and thereby defer it. Third, investors can claim income tax relief of 30 per cent if held for a minimum of three years. Fourth, they’re outside your estate for inheritance tax if held for two years, at which time they benefit from business property relief (BPR). Lastly, if the investment doesn’t pan out, you can offset losses against tax.

This last advantage shows the risk these investments take. If you lose 100 per cent (70 per cent if you have received 30 per cent tax relief) of the investment, you can offset that loss against income tax. Let’s assume you’re a 45 per cent taxpayer. You invest £100,000, and get £30,000 tax relief. If you lose the £70,000, you can offset this loss at 45 per cent or £31,500.

Now for VCTs. First, holders of these investments can again claim income tax relief of 30 per cent, if they are held for five years. Second, there’s no CGT on disposal. Third, the dividends are tax free — and those dividends are great for retirement income.

The beauty of EIS and VCTs is in their role as tax reducers - that important distinction with pensions. For pensions, you need a certain level of income to make a contribution, and it needs to be earned income. With EIS and VCTs you can reduce your income tax bill, wherever it comes from, to nil.

In other words, if you have an income tax bill of £30,000, this can be reduced to nil with a £100,000 contribution. It’s important to bear in mind, though, that tax treatments will depend on your individual circumstances and may change in the future.

I have always found it incredible that, if you have the capital, you can mitigate your income tax bill every year. But that is only half the story when it comes to these investments. The other part of the equation is what companies you should invest in.

With VCTs you are broadly buying into an existing portfolio. With EIS investments you literally own shares in that company. An example of one that was a recent success for a client of mine was Bloom & Wild, an online flower company which was doing well even before its sales surged under lockdown.

These investments need to be found, and more importantly, exited. Owning an investment that is worth more than you bought it for does not make you a great investor. Selling it at a profit does. Of course, for every Bloom & Wild there is inevitably a company which went to zero. But remember the loss relief.

You may conclude this is a tax break for people who can afford it. This is of course true, but why would HM Revenue & Customs allow such tax breaks with no upside? This is the societal payback that I love about these investments: you invest in a small company and you can help make it successful. With success, it pays corporation tax, income tax and national insurance on income paid to its employees and, if the business is eventually sold there may be CGT payable by the entrepreneur who set up the business. These tax receipts can show a return to the exchequer, and the return to society.

Calculus Capital, an EIS fund, has made some estimates about the scale of this payback. if we assume an income of £35,000 for employees of an EIS company (just higher than the national average) then in 2019-20 the income tax and national insurance paid would be approximately £11,500. If the company created nine jobs for the three-year holding period of an EIS, this would pay for the tax relief of roughly £300,000 (9 x 3 x £11,500) on a £1m investment.

Add in corporation tax and assume that these employees will be employed over the long term, and the breakeven is three years; while in five to 10 the exchequer should be receiving quite a windfall, more so than that of the investor.

I stress it’s important to get advice from a regulated adviser on your tax position and the higher degree of risk associated with this type of investment. You always need to see why you are getting a tax break and — if it looks too good to be true — avoid. With EIS companies and VCTs there are higher risks to capital, and it could be a lengthy investment period. Failing companies can take years to fail completely.

But these can be a very interesting type of investment, with great tax breaks, potentially high returns and a valuable societal outcome. “Right on the jack”, as they might say on the bowling green.

Michael Martin is a private client manager at Seven Investment Management. The views are personal. Twitter: