We look at how these products work and some success stories from the sector
Venture capital trusts offer significant tax benefits but are they suitable for all investors?
The new venture capital trust (VCT) offer season is now in full swing where investors are able to apply for new shares and enjoy immediate tax benefits.
Recent offers from Amati AIM VCT, Octopus AIM VCT and Hazel Renewable Energy VCT have already closed, having hit their subscription target. Others are filling up quickly.
Each year VCTs seem to attract money faster than the previous year, meaning interested investors need to act fast once offers go live.
This article will explain all the essential points about why and how to invest in VCTs, plus the important points to note if you want to lower the risk of losing money.
WHY WOULD YOU WANT TO INVEST IN A VCT?
Venture capital trusts are funds that allow investors to claim up to 30% income tax relief on up to £200,000 invested in a VCT per year. You need to hold the investment for at least five years, but any dividends will be tax free and you will have a capital gains exemption on disposal.
The tax benefits are essentially compensation for taking on the extra risks of investing in growth companies, some of which could be early-stage businesses.
WHO IS BEST SUITED TO INVESTING IN A VCT?
Individuals on higher-rate or additional rate tax bands are naturally drawn to VCTs because of their tax benefits.
VCTs can also be of interest to someone who wants to invest in early stage growth companies or individuals who have maxed out allowances on various wrappers such as ISAs and hit or exceeded the £1.03m pension lifetime allowance.
These funds are popular among individuals seeking to supplement their income because dividends and returns from selling down capital are tax free.
Stuart Veale, managing partner at asset manager ProVen, says VCTs are not simply the domain of high net worth individuals, noting that the average investment size in its products is £12,000 and that many investors opt for its minimum £5,000 subscription.
Hugi Clarke, a director at VCT provider Foresight, says there are two obvious candidates for the VCT market. One is someone trying to resolve a persistent tax problem; the other is someone with a one-off exceptional tax
charge as you can use the 30% relief to reduce your tax bill.
‘It is becoming quite common for people to face lifetime allowance issues,’ says Clarke, referring to the limit on the amount of pension benefit that can be drawn from pension schemes and paid without triggering an extra tax charge.
‘Individuals in this situation may have either built up a sizeable pension pot, or they’ve transferred out of a defined benefit scheme with a substantial sum of money.’
One solution for anyone in this situation who is still saving for retirement is to put further contributions into a VCT rather than a pension as it is more tax efficient in such circumstances. It is very important to understand the risks if taking this route.
VCTs can also benefit individuals who haven’t hit the pension lifetime allowance, assuming they are happy to let their money grow and don’t need to access it in the near-term.
For example, a 40 year old could invest money into a VCT and get 30% tax relief. After five years they can reinvest the proceeds of that first VCT into a new product and get another 30% tax relief. If they repeat this pattern, the individual could have invested in five VCTs backto-back in five year batches and enjoyed considerable tax relief by the time they turn 65.
They could then take this money as a tax free lump sum in retirement or keep the money invested in a VCT and draw tax free dividends as an income.
The downside of the latter strategy is that VCT investments may be too risky for someone of that age. And don’t forget that you shouldn’t invest in something for the tax breaks alone.
WHO SHOULDN’T INVEST IN A VCT?
VCTs should be avoided if you need to access your money in less than five years and if you don’t have the stomach or patience for exposure to earlystage businesses.
Selling before five years is up will require you to pay back the 30% tax relief to the taxman. You also have to consider there isn’t always a liquid market for VCTs as most people only buy them in an offer period and don’t trade them on the market. That said, some VCT providers do offer to buy back shares at a 5% to 10% discount to net asset value.
‘Someone who is equity market risk averse shouldn’t invest in a VCT,’ says David Stevenson, fund manager at Amati. ‘The tax benefits would be outweighed by the fact they can’t sleep soundly at night.’
Stevenson suggests other people not suited to VCTs are those who are under-invested in a pension, don’t have a pension at all, or are a non-taxpayer.
HOW DO YOU BUY THEM?
You should buy VCTs direct from the fund manager or a specialist VCT broker during the offer periods to get all the tax benefits.
You can buy VCTs on the open market (also known as the secondary market) but you would lose the 30% income tax relief.
THE DIFFERENT TYPES OF VCTS
There are three different types of VCTs, each suitable for different types of investors: Generalists, AIM VCTs and Limited Life VCTs.
VCTs often invest in early-stage businesses where a talented group of individuals are trying to commercialise a bright idea
VCTs aren’t always about investing in the next big thing. Sometimes they can include stakes in businesses growing at a slower pace like garden centres