A boost for venture capital trusts

“Beat the Budget” scare stories often turn out to be unfounded. In the weeks running up to Rachel Reeves’ first Budget, investments in venture capital trusts (VCTs) accelerated amid speculation that the new Chancellor might be tempted to cut back on the tax perks offered by these funds. In the event, such speculation proved wide of the mark; indeed, the VCT sector effectively received a boost from the Budget.

Remember, VCTs are a specialist type of investment trust offering exposure to small, early-stage businesses. They are expected to invest at least 80% of the funds they raise from investors in businesses worth less than £15m and with fewer than 250 employees; these businesses must not be more than seven years’ old at the time of the VCT’s investment.

The positive take is that these are acorns that could one day grow into oaks. Equally, small, early-stage businesses are more at risk of failure. VCT returns can therefore be volatile – though investing in a portfolio of businesses via a fund offers diversification benefits.

To compensate for these elevated levels of risk, the government has long offered tax incentives to VCT investors. You get income tax relief at a rate of up to 30% when investing in new VCT shares; dividends paid by the funds are tax-free; and there is no capital gains tax (CGT) to pay on any profits that you make on your investment.

These benefits all survived the Budget unscathed, and the regulation is now in place to ensure the VCT scheme carries on until at least 2035. Moreover, other Budget changes make VCTs look more attractive. Higher CGT rates, for example, have increased the value of CGT-free investments. The fact that VCTs are allowed to hold shares in some companies listed on the Alternative Investment Market (AIM), where inheritance tax costs are now increasing, is also alluring. VCTs provide a tax-efficient route into the AIM, despite the looming inheritance tax headache.

Now, the critical point to make against this backdrop is that investing simply to secure a tax benefit is not a good idea. VCTs, with their elevated risk profile, have to make sense to you as an investment proposition before you start worrying about tax matters. If you aren’t using your full annual individual savings account (ISA) allowance to invest in shares, doing so before you move on to VCTs is likely to make more sense than jumping straight in.

Still, the allure of VCTs, even leaving aside their advantageous tax treatment, is considerable. The businesses in which these funds invest have the potential to grow rapidly, generating significant returns for early-stage investors.

Importantly, however, if VCTs interest you, it may be necessary to move quickly. Each tax year, VCT managers launch new funds – or issue new shares in existing funds – because it’s only brand new VCT shares that qualify for upfront income tax relief (shares traded on the stock market don’t get it). These new issues can often sell out well before the end of the tax year because managers are anxious not to raise more money than they feel they can find investment opportunities for.

Sell-outs may happen more quickly this year, given that VCT tax perks have survived a budget that will hit many other investments. Indeed, Wealth Club, an adviser specialising in the VCT market, says five funds have already closed to new investment this tax year.

Don’t be rushed. If you think VCTs could be a good investment for you, take your time to consider your position – and to compare the various funds on offer. Seek independent financial advice if you’re not sure about how to move forward.
Equally, don’t leave your VCT investment to the final few days of the tax year next March or April. You may find you have missed the boat. You can find out more about VCT’s in the AIC’s guide, here.