Venture Capital Trusts (VCTs) are investment trusts that invest in small companies who require finance in order to further develop their business.
Because VCTs invest in small companies which are in early days of development, they are higher risk than a standard investment trust. Given the high risk of financial failure of early stage businesses, these are not investments for widows and orphans.
So why invest into a VCT? Well, the government is keen for us all to invest in start-up companies (particularly as the banks currently won’t) so there are a number of carrots dangled in front of investors in an attempt to offset the risks, in the form of generous tax breaks.
The tax benefits of a VCT will be attractive to high rate tax payers. Tax payers receive an income tax rebate of up to 30% when investing in a VCT. You can invest up to £200,000 a year in a VCT and receive income tax relief on the entire sum – this makes sense provided you are aware that you cannot receive more in rebates than you have paid in income tax.
When you eventually sell your VCT holdings any gains you have made will be exempt from capital gains tax (CGT). Dividends received while you hold the VCT are also tax-free.
Are there any drawbacks?
The income tax rebate is only available when you buy a new issue of shares in a VCT or a top-up, not on VCTs bought on the secondary market. Beware, as VCTs bought on the secondary market still count towards the £200,000 annual allowance.
You have to invest in a VCT for at least five years in order to get the tax benefit. If you sell your VCTs less than five years after you bought them you will have to pay the rebate back.
If the VCT fund manager must keep to the rules –70% of its assets must be invested in qualifying companies at all times, if not, the tax relief would have to be repaid in full.
As mentioned earlier, VCTs are risky but some have delivered fantastic returns for investors. But for for every VCT that is successful, there are two or three that have lost money. It is essential to take advice.
Different types of VCT
There are two different types of VCT. The generalist VCTs are open-ended vehicles which are best for investors who are looking for high-risk, high-return investments and therefore want to make long-term investments in start-up companies.
The second type is the lower-risk planned-exit VCT. These VCTs offer lower potential returns – most of the growth in your capital tends to come from the tax relief. These funds invest in firms with proven revenue. The trusts tend to wind up after five years and return the original investment. So if you invested £1,000 in a planned-exit VCT, you would get £300 back in a tax rebate, and then if the fund makes 10% over five years, you would get £1,100 back.
But clearly, there’s no guarantee that you’ll get your money back – even the ‘lower-risk’ VCTs can easily lose money – so don’t imagine that this is a way of getting the tax benefits without taking the risk.
So while the tax breaks on VCTs are very attractive, especially now that the 50% rate has kicked in, you shouldn’t let that disguise the fact that these are high risk investments and that professional advice is essential.
Do you have any questions on VCTs, or any other aspect of financial and tax planning advice both corporate and private clients – e-mail us.