How to successfully invest in VCTs

  • Describe what VCTs are and why one should invest in them
  • Explain how to identify a good VCT
  • Describe some of the singular features of a VCT
How to successfully invest in VCTs
(FT Montage)

With the end of the tax year approaching, advisers will be making sure their clients' portfolios are in a good position for the year ahead.

In particular, they will be ensuring that all personal allowances are being taken advantage of.

These personal allowances, the amount an individual can earn without paying tax, have been shrinking in real terms over the past few years as thresholds have not risen in line with inflation.

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As a result of this, 1mn people will be pulled into higher tax bands by 2027 according to HM Revenue and Customs.

One of the most important tax thresholds, the lifetime allowance, which is the amount a pension holder can benefit from without paying extra tax, was frozen at just over £1mn in the 2021 Budget, and will remain at that level until at least 2025-26.

One area that can provide some tax relief for investors are venture capital trusts.

These are listed companies that invest in early stage start-ups, and their popularity has increased hugely in recent years, with more than £1.2bn raised in the 2021-22 tax year.

If advisers are thinking about recommending a VCT to a client, it is important to research these vehicles properly as VCTs are not suitable for everyone.

What are VCTs?

A VCT is an investment company listed on the stock exchange.

The trusts were introduced in 1995 as the government tried to encourage consumers to invest in more high-risk companies, enticing them with tax breaks as the end investments are fairly risky.

VCTs invest in early stage, high-risk, unquoted UK businesses (or those listed on the Alternative Investment Market), and investors are eligible for a 30 per cent income tax relief on investments of up to £200,000 each year.

There are strict rules on the companies VCTs are allowed to invest in, including that they are UK-based and what they can spend investors’ money on, and a number of VCTs work closely with the companies they invest in, sometimes putting a director on the firm’s board.

There is also no tax on dividends received from VCTs, and investors do not pay capital gains tax on any share disposals up to £200,000.

The number of VCTs raising and managing money fluctuates year to year, and last year there were 52 VCTs managing funds, of which 46 were actively raising funds, according to HMRC.

What are the different types of VCT?

There are two types of VCTs. Most are generalist VCTs, which invest across a range of sectors, though some will focus on younger, smaller companies that are not yet profitable, while others focus on larger firms.

Generalist VCTs invest via loan notes, preference shares, or equity in the business.

An Aim VCT is what it says on the tin: it focuses on companies listed on the smaller companies' stock exchange in the UK. 

The main difference between Aim VCTs and generalist VCTs is the potential volatility in the share price of Aim firms. These are more liquid however, as the shares are traded on an exchange.