VCTs recently celebrated their 20th anniversary and although the sector is still relatively young, it has managed to deliver consistent returns. Here are five things to know about VCTs.
What are VCTs?
The VCT scheme started on 6 April 1995 and invests mainly in small, private up-and-coming companies with high potential for growth that need some financial support. They may be higher risk than conventional investment companies but they are viewed as long-term investments that also offer generous tax benefits.
Previously, VCTs were companies listed on the London Stock Exchange, but from April 2011 these are companies admitted to trading on a regulated market. In order for a VCT to function, it needs to be approved by HM Revenue & Customs once they meet certain conditions. An approval from HMRC satisfies VCT requirements enabling investors to qualify for certain tax reliefs.
How to invest in a VCT fund.
Like all investment companies, investors can buy existing VCT shares through the stock market. One thing to consider before investing is the type of VCTs. There are three main sectors – Generalist, Aim and Specialist. Generalist VCTs invest in a wide range of companies in different sectors while Aim VCTs mainly invest in companies quoted on AIM or other similar markets. Specialist VCTs invest in more specific areas, such as the environment, infrastructure, media, leisure or technology.
What are the advantages of investing in a VCT fund?
Investing in VCTs means investor are entitled to various income tax and capital gains reliefs. The rate of income tax relief on subscription is 30 per cent and the minimum time an investor must hold a VCT to qualify for income tax relief is five years. VCTs are also exempt from corporation tax on any gains arising on the disposal of their investments. Investors pay no income tax on any dividends received and no CGT on any profits made on the sale of shares. These two reliefs are available to investors at all times, irrespective of how much they invest. However, if shares are issued on the launch of a VCT or when it raises new money, further tax relief is available to reduce an income tax bill – providing the investor holds the shares for a minimum period of time and subject to certain limits and conditions. This is known as initial income tax relief.
The risks of VCTs.
One of the biggest risk is investing in small and young companies. Since VCTs generally tend to invest in companies that are not very well established, they face the risk since these companies may not have a large cash resource to fall back on in tougher times. There is also the risk of valuation. Analysts have warned that investors needs to keep an eye on valuation as sometimes, due to broader investor sentiment in the stock market, investors tend to pay more for an investment than the actual worth. Market risk is also a factor since VCTs are currently benefiting from a low interest rate environment but what happens when the interest rates start to go up.
Will the changes proposed in the VCT sector impact investments?
No. The changes proposed in the VCT sector by chancellor George Osborne in his summer Budget are part of ongoing discussions with the European Union about the state aid approval for the scheme. The changes proposed include age requirements for qualifying companies and a reduction of the lifetime limit for tax-advantaged funding. According to the Budget, companies will be eligible for VCT investment within seven years of their first commercial sale, and 10 years for knowledge-intensive companies. This is down from 10 and 12 years respectively, as stated in this year’s March Budget. The government also plans to introduce a cap on the total investment a company may receive through the enterprise investment scheme (EIS) and venture capital trusts of £20m, for knowledge intensive companies and £12m for other qualifying companies.
