VCTs got their own start in 1995, when the Conservative government at that time introduced tax breaks to encourage investors to put their money into domestic early stage companies – an area that many tend shy away from, as young companies with no business track record are often perceived as overly risky.
While getting in on a promising new company in the early stages of development can appeal to some, the main draw for VCT investors has proved to be the tax breaks they enjoy. HM Revenue & Customs has stated that shareholders who are over the age of 18 can claim income tax relief at a rate of 30 per cent on annual investments of up to £200,000, as long as the shares are held for at least five years.
Investors also pay no income tax on dividends from ordinary shares, and no capital gains tax is due when individuals decide to sell their ordinary shares in VCTs.
Similarly, EISs are also frequently in focus for tax-efficient investors. They can claim a 30 per cent tax relief on up to £1m worth of shares. Shares are also eligible for a capital gains tax exemption, as well as capital gains tax deferral relief, and investors who sell their shares at a loss can offset this, minus any income tax relief given, against income in either the year in which they were disposed of or the previous year.
Tax benefits
These tax benefits, in combination with the tighter limits on pension tax relief, have resulted in a surge of inflows into VCTs and EIS.
VCT fundraising in the 2016/17 tax year to the end of February 2017 was £270m, compared to £204.4m during the same period in the previous tax year, according to data from the AIC.
The spike in the 2004/05 and 2005/06 tax years seen in Chart 1 is due to upfront VCT tax relief being raised to 40 per cent, although it was subsequently reduced back to 30 per cent.
There is however a snag in the recent success. Rule changes from 2015 have made it more difficult for VCTs to find qualifying companies to invest in. Under the new rules, companies will normally have to have made their first commercial sale in the past seven years – or 10 years for companies that are deemed to be knowledge intensive. In addition, money from VCTs cannot be used to fund management buyouts and acquisitions.
