Venture capital trusts (VCTs) have turned 21 and more people than ever are using them.
The UK government established venture capital trusts more than 21 years ago to encourage investment into smaller UK businesses.
The generous tax benefits offered compensate for the increased risk associated with investing in smaller, less liquid companies.
Since their introduction in 1995 to the end of the 2015/16 tax year, venture capital trusts have raised over £6bn according to the AIC, providing important support and funding to the UK’s SME sector.
And despite a number of rule changes for venture capital trusts last year they continue to be more in demand than ever before with just under £500m raised in the 2015/16 tax year.
Research from the Association of Investment Companies (AIC) also suggests historical performance has been strong.
The average total return for a venture capital trust investment of £100 to 31 December 2015 was £160 over 5 years and £187 over 10 years.
(Source: AIC).
How VCTs work
In many ways, VCTs are similar to investment trusts but with additional investment rules in order to qualify for tax reliefs. VCTs are plcs and are listed on the London Stock Exchange. Investors subscribe for shares in a VCT, which will then look to invest into a portfolio of “qualifying” companies.
There are several investment criteria underlying companies must meet to be VCT qualifying including, but not limited to:
- Companies must be unquoted or AIM listed
- The maximum value of a company’s Gross Assets (before VCT investment) is £15m
- The company cannot have more than 250 employees (before VCT investment)
At least 70 per cent of a VCT’s cash must be invested in qualifying companies within three years. The remaining 30 per cent can be invested in non-qualifying investments, such as cash, listed equities, debt and investment funds.
Because of the numerous rules to which VCTs must adhere in order to qualify for tax breaks, it is important to choose an experienced manager. We will be going into more detail on what to look for in a VCT manager in next week’s article.
Tax benefits
Venture capital trusts have a number of attractive tax benefits for investors. Initial investments can qualify for 30 per cent income tax relief, subject to a maximum of £200,000 for each investor per tax year and a five year minimum holding period.
Furthermore, dividends paid are tax free and there is no capital gains tax (CGT) to pay when the VCT is sold.
Types of VCT
All VCTs invest into smaller UK companies however the market tends to split managers into four main types: Generalist VCTs, Aim VCTs, Specialist VCTs and Limited Life or Planned Exit VCTs.
The role of a VCT in an investor’s portfolio
Financial advisers should analyse the venture capital trust market thoroughly before recommending them.
The AIC website provides a lot of useful research and information in this regard. There are also other good sources of independent information such as The Tax Efficient Review, Intelligent Partnership’s VCT Industry Report and The Tax Shelter Report.
What type of clients are VCTs suitable for? Firstly, VCTs should be considered on their investment merits rather than simply a way of accessing tax reliefs. Given their focus on smaller, less liquid companies, VCTs will not be suitable for every client.
However it is also worth noting, that given the VCT industry has been running for over 20 years it is possible to find VCTs with large and mature portfolios, many of these have started to develop the hallmarks and traits of a smaller companies investment trust, and if investors can get access to a top-up offer within one of these portfolios it can help to potentially lower the investment risk.
Given the changes to pension legislation in the last couple of years there seems to an ever increasing demand from investors for VCTs who have capped out on either the lifetime limit or their annual contributions.
With their upfront income tax relief at 30 per cent and tax-free dividends you can see the attraction for people using them as a supplementary pension planning option, building a diversified portfolio of different VCTs over time, to sit alongside their pension.
As Chris Hutchinson, manager of the £150m Unicorn Aim VCT says: “VCTs are sometimes mistakenly considered as being solely focused on achieving returns through capital growth, but in reality many VCTs deliver attractive returns via regular tax-free dividend payments.”
