Venture Capital Trusts

Pros

  • Specifically designed to support small UK enterprises.
  • No tax payable on capital gains or dividends.
  • Thirty per cent tax relief.

Cons

  • Small firms more inclined to failure than large firms.
  • Investment illiquid, five year holding to receive tax relief, may hold shares even longer.
  • May be difficult to invest with higher demand due to changes in pension allowances, and lower supply due to government legislation over eligible companies.

On April 6th the government made changes to pension allowances, meaning those earning over £150,000 a year will see their annual allowance tapered down to £10,000 by the time they are earning over £210,000. This means investors who have maxed their ISAs and pension allowances will likely be eyeing up venture capital trusts (VCTs) as an alternative tax-efficient form of investment.

…not only are you encouraged by the taxman to pay less tax, but you are also playing a part in promoting UK small businesses.

The VCT scheme was founded in 1995 as part of the Conservative government’s Finance Act, a way of encouraging individuals to invest into UK businesses. Investment trusts, listed on the stock exchange, receive funding from investors and invest that money into companies with specific criteria eligible for the VCT scheme (see below). To compensate for the risk of investing in small UK enterprises the Government offers a 30 per cent tax relief, and there are no capital gains or dividend taxes. Therefore not only are you encouraged by the taxman to pay less tax, but you are also playing a part in promoting UK small businesses.

Rules

  • Yearly investment allowance approx. £5,000 minimum depending on Trust, max. £200,000.
  • Government pays out 30 per cent tax relief as long as the VCT shares are held for five years.
  • VCT holdings are not exempt from inheritance taxes.
  • VCTs must invest 70 per cent of raised funds in qualifying investments by three years.
  • Qualifying companies have the following characteristics: net assets less than £15mn, less than 250 employees, the company is unquoted or listed on the AIM, must be less than seven years old.

The trusts offer funding to UK enterprises through loan facilities (alongside share ownership) and therefore receive a steady income, which can be returned to shareholders through tax-free dividends. This is an attractive alternative to other ‘income’ investments, such as the UK 10 year gilt, which is only yielding 0.68%. VCTs have a historical return of 5 per cent.

The investment itself is, however, very risky. Not only are small enterprises more likely to fail than larger firms, but the VCT investment is illiquid. Shares sell at large discounts on the secondary market and you lose your tax relief if you sell prior to five years. Most VCTs return the money to the shareholders after a pre-determined period by paying out one large dividend, whilst others see the investment through the long run, only paying out when the small enterprise itself buys back the shares, or is bought out by another firm.

VCTs investments will also become more difficult to secure this year. The increased popularity from reduced pension allowances is likely to outstrip the supply of available investments, with the Government cracking down on specific tax avoidance sectors, such as the Film Industry. With a requirement to invest 70 per cent of raised funds within three years, VCTs may reject investor demand to ensure they abide to government regulation.

How do I invest?

A number of brokers offer access to a range of VCTs, such as Hargreaves Lansdown. This is a great way of seeing an overview of different VCTs, their costs and minimum investment allowances. You can also invest directly into the funds via their websites; Octopus Investments is particularly notable having supported Graze and Zoopla. NVM private equity and Calculus are also players in this field.

Typically you would not want to invest in VCTs until you have maxed your pension and ISA allowances, which are £40,000 and £20,000 respectively from 2017. They continue to be the two best saving tools for individuals. You would also need to consider the illiquidity of investing in VCTs, with a minimum holding period of five years and potential average holding of ten to twenty years. Furthermore if inheritance tax (IHT) is a concern, you may want to consider the Enterprise Investment Scheme, which is a VCT alternative offering exemption from IHT. Despite being down the pecking order VCTs still provide a valuable financial tool to invest more efficiently, and offers invaluable assistance to small UK enterprises.

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