Feeling adventurous? These trusts can boost your cash

AGOVERNMENT assault on the ability of high earners to fund a pension has resulted in a sudden voracious appetite for tax-friendly – but risky – venture capital trusts. Brokers who specialise in enabling people to buy into these trusts say demand is stronger than ever. Already this tax year, some £235 million of purchases have been made, compared with £542 million for the whole of the previous year.

‘It is going to be a bumper year,’ predicts Jason Hollands, a director of wealth manager Tilney, which is among those companies that run a rule over all new trust offers.

Venture capital trusts invest in embryonic businesses, providing them with much needed capital to grow. Most of the companies are private, though some are listed on the AIM market.

The trusts provide an engine for economic growth. According to a recent report issued by the Association of Investment Companies, they enable a typical business in receipt of funding to more than double its turnover. Since the end of 2015, 63 per cent of businesses receiving backing from trusts have been less than a year old.

The trusts are listed on the stock market and make returns for investors by selling the businesses they invest in at a profit.

Of course, it can be a hit-and-miss affair as some start-ups fall by the wayside.

Though these trusts provide an economic boost, it is the attractive tax breaks they offer that lure most investors into them.

Anyone investing in a new venture capital trust – or a new share issue by an existing trust – gets a big tax incentive to do so. They receive 30 per cent tax relief on their contribution.

So a £10,000 investment will cost them only £7,000. In the current year, the maximum that can be invested is £200,000. Investing in an existing trust – other than through a new issue of shares – does not qualify an investor for tax relief, though it does count towards their £200,000 annual limit.

The tax relief does not come without conditions. It has to be paid back if an investor sells their holding within five years.

On the surface, the 30 per cent relief on offer does not compare favourably with the 40 or 45 per cent relief available on investments into a pension fund for higher and additional-rate taxpayers.

But recent clampdowns on the amount high earners can put into a pension have pushed some towards venture capital t rusts. These restrictions include a reduction in the size of pension fund that someone can accumulate – the so-called lifetime allowance – before the Government applies tax charges of up to 55 per cent on any excess. This now stands at £ 1 million, compared with £1.8 million seven years ago.

They also embrace a cut in the amount additional-rate taxpayers can put into a pension every year – in some cases from £40,000 (the maximum for all taxpayers) to as little as £10,000. The Government may also introduce further restrictions on pension saving next month in the Budget.

Hollands says: ‘The Government is making it more difficult for high earners to fund pensions. As a result these taxpayers are looking at other legitimate ways to invest in a tax-friendly way. Some are utilising their annual Isa allowance of £20,000. Others are being drawn to venture capital trusts by the tax relief on offer.’

There are other tax attractions associated with venture capital trusts. Dividends are tax-free, as are any capital gains made from investing in a trust. Indeed, the dividend payments can look favourable against those available from other investments. This is because the trusts are able to distribute part of any profit from holdings they sell to shareholders as income. It leads to a high but lumpy dividend.

Investing in venture capital trusts is not without its risks or drawbacks. The underlying investments are unproven businesses that are prone to failure, resulting in disappointing returns for trust investors. But a number of venture capital trust managers, including Albion, Downing, Mobeus and NVM Private Equity, have built proven track records of picking more winners than losers.

Given the research involved in searching out potential investments – and then monitoring them – venture capital trusts carry high initial and annual charges. These can be mitigated by investing through a broker such as Tilney or Chelsea Financial Services.

Selling trust shares can also prove difficult as a result of the thinness of the market – there are few buyers and sellers.

There is also a danger that the current tax breaks may soon be curtailed – a fact that part explains the recent splurge in new trust share issues.

The Treasury has been looking at ways in which more start-up businesses can be encouraged to thrive through long- term investment – so-called ‘patient’ capital. One suggestion is t he setting- up of a national i nvestment fund that would back new companies.

The Chancellor is expected to announce more details in next month’s Budget. But one consequence of the review could be changes to tax relief.

‘It is 50:50,’ says Darius McDermott, managing director of Chelsea Financial Services, ‘though I would not encourage anyone to invest in a trust just because a tax break is threatened. The investment case has to be robust.’