What are Venture Capital Trusts and what do they offer? 

 A common goal of many people is how do they reduce the level of income tax they are paying having worked so hard to earn their income in the first place. 

 Whilst in many cases some more simple and traditional planning strategies can benefit from tax relief, for example pension contributions, there are some people who are constrained by how much they can contribute to a pension or, because they are projected to be liable to a Lifetime Allowance tax charge on their pension savings, the benefit of tax relief obtained on contributions is reduced. 

In these instances, and very much depending on the individual circumstances, a VCT could potentially offer some valuable tax relief. Here we consider the background of VCTs, what they invest in and the potential benefits these alternative investments offer.  

 

What are VCTs? 

 Venture Capital Trusts (VCT) were introduced by the Government 6th April 1995 aimed at encouraging people to invest in smaller companies whose shares and securities are either unquoted or listed on AIM (the London Stock Exchange’s market for growth companies). These businesses need investment to develop and can potentially give investors a high return, but they can also be much riskier than larger, more established companies. 

 The type of companies VCTs invest in can cover a wide variety of sectors, from early-stage tech companies to high-end niche manufacturers, retailers, clothing brands and many more. Some VCT-backed companies have become household names, including Zoopla, Gousto, Virgin Wines, Everyman Cinemas, Graze and Cazoo. Of course, the businesses that have unfortunately failed and no longer in business are not remembered. 

 There are several rules in place to determine which companies can qualify for VCT funding. HM Treasury sets these rules to make sure that VCTs continue to meet the Government’s policy objectives, with money being directed to those companies most in need of finance to grow. 

 The following are some of the rules currently in place: 

 A company must have a permanent establishment in the UK and carry out what HM Revenue & Customs calls a ‘qualifying trade’. Most trades are allowed, but with a number of exceptions that HM Treasury do not believe are in need of additional financing support. Some examples of these currently include land dealing, financial activities, forestry, farming, running hotels and energy generation. 

• It must be relatively small, typically with gross assets of £15 million or less at the time of the investment and have fewer than 250 full-time employees when the investment is made. 

• A VCT can invest up to 15% of its money in a single company. Each company is allowed to receive up to £5 million of VCT or other tax-efficient funding in any twelve-month period, with a cap of £12 million over its lifetime. 
• VCTs are expected to invest in companies that are less than seven years old from the date of their first commercial sale.  

 

Are there any benefits? 

 To encourage support for these businesses and to offset a small element of the risks associated with VCT investments, the Government offer generous tax benefits for VCT investors, which are as follows: 

 Income tax relief  

 An investor can claim up to 30% upfront income tax relief on the amount invested, provided the investor keeps the VCT shares for at least five years, has sufficient income tax liability and the amount of relief cannot exceed the amount of income tax due. 

 For example, an investment of £100,000 into a VCT could generate £30,000 of income tax relief should the investor have an income tax liability of £30,000 or more. This tax relief would effectively reduce the cost of the initial investment to £70,000.  

 An investment into a VCT must be held for at least 5 years otherwise this tax relief can be clawed back HMRC. 

 

 Tax-free capital gains 

 Should an investor decide to sell the VCT shares they own and make a profit, ordinarily this would be treated as a capital gain. However, within a VCT the proceeds are exempt from Capital Gains Tax. 

 

 Tax-free dividends 

 If a VCT pays dividends, these are tax free and an investor would not need to declare them on a tax return.  

 If a VCT were to pay a tax-free dividend of 5%, that would be equivalent to a taxable dividend of 7.4% for a higher-rate tax payer and 8.1% as an additional-rate taxpayer. 

 The tax-free capital gains and dividends could be clawed back if full approval is withdrawn at any time during the investment period. 

 

Summary 

 As with all investment which offer attractive tax reliefs, VCTs are classed as high risk (and potentially speculative risk) investments and investing in small, early-stage, VCT qualifying companies is unpredictable and suited for investors who are comfortable with the high risks associated. 

 As always, as part of our ongoing service we consider the suitability of these investments to meet our client’s needs. It is important to stress that these types of investments are not suitable for everyone, and we need to ensure appropriate consideration is made of the associated risks alongside the benefits. However, from the above you can see some of the potential benefits offered by these investments.  

Should you wish to receive further information or discuss these or any other specific solutions, please do not hesitate to contact your Financial Planner who will be more than happy to discuss this with you.