A mixed bag for VCT investors

The effect of this change, over time, will be to lower the risk profile of many VCT portfolios. The fund’s investee companies will still be relatively immature, certainly compared to most stock market listed businesses, but some of them will be larger concerns, built on more solid foundations. That should reduce the number of failures that VCTs have to deal with.

Less happily, while investors currently benefit from upfront income tax relief of 30% on annual investments in VCT shares, this will fall to 20% from the 2026-27 tax year. The upfront relief is only available on new share issues, which is why VCTs launch funding rounds each year. Previous tinkering of this type has dramatically depressed demand. A reduction in upfront relief from 40% to 30% in 2006, for example, saw fundraising fall by 65%.

Inevitably, reduced tax relief has an effect on returns. Your total return at the end of your investment from a fund that gave you a 30% upfront boost will, all things being equal, be greater than one that provides only 20%.

So, where do these changes leave investors? Well, the first point to make is that if you’re thinking about investing in a VCT in the current tax year, nothing has changed. The Budget announcements don’t come into effect until next year. Indeed, if VCTs are part of your long-term financial planning strategy, it makes sense to hunt out the best opportunities before the end of the tax year to get as much upfront income tax relief as possible.

As for the future, it’s important to recognise that VCTs will still offer generous tax incentives, including tax-free income and capital growth, as well as relief on your initial investment. You’re also allowed to put up to £200,000 into VCTs each year – that’s ten times more than you can put into individual savings accounts (ISAs), and more than three times more than the maximum investment allowed in tax-efficient private pension plans.

Most financial advisers will tell you it’s a good idea to make use of your ISA and pension allowances before moving on to VCTs – to use the former schemes to build up a base of conventional investments, with VCTs then providing some extra spice through exposure to early-stage businesses. That advice still seems sensible.

For most people, the debate shouldn’t be between the tax merits of competing tax-efficient investment plans. Rather, your goal should be to find the right type of investment given your needs, goals and attitude to risk.

There’s an old saying in financial planning: don’t let the tax tail wag the investment dog. It remains good advice. Make your savings and investment decisions on the basis of your long-term objectives, rather than simply to net a tax saving. For many investors, the best VCTs will continue to offer a compelling investment opportunity, delivering both income and capital gains.

Will reduced upfront income tax see fundraising come down next year? Probably – that has been the experience of the past. However, that’s an issue for VCT managers and the industry as a whole, not you. Individual VCT investors should worry about what’s right for them, rather than what others are doing.