In praise of VCTs

Wow. That seems like the only fitting word for new statistics from HM Revenue & Customs that show sales of venture capital trusts (VCTs) reached £1.122bn over the 2021-22 tax year ending last April. That represented a 68% increase on fundraising in 2020-21, itself a pretty good year for VCT sales.

For advisers, HMRC’s publication of these statistics comes at a timely moment. With many clients scrambling to submit self-assessment tax returns by the 31 January deadline, the VCT sales figures are a reminder of just how important these investment funds are becoming. They provide attractive long-term investment potential as well as remarkable tax efficiency.

That combination looks even more winning in the current climate, with tax-efficient savings opportunities increasingly curtailed. The individual savings account (ISA) allowance has remained at £20,000 for a number of years now and any increase feels some way off. More seriously, private pension saving contribution limits – both the annual and the lifetime allowance – are stuck, and wealthier savers face increased restrictions.

That makes VCTs a rare beacon of light in this regard. The funds offer 30% upfront tax relief on purchases of new shares – so a £10,000 investment reduces the client’s tax bill by £3,000 – as well as tax-free income and capital growth. In practice, many VCTs are structured to generate attractive dividend flows; with no tax to pay on the income, that can prove very useful to investors struggling to generate yield from other assets in this low interest rate environment.

We should not, of course, allow the tax tail to wag the investment dog. VCTs take stake in small, early-stage businesses that are, by definition, more likely to flounder or even to fail outright. But while this makes the funds more risky than many other collective investment vehicles, mitigation is provided by the unquoted investment experience and expertise of VCT managers and the diversification benefits of a portfolio approach to this area of the market. Besides, investors are 30% up before they start, courtesy of that tax relief.

That doesn’t mean any VCT is a sure-fire winner. The most successful early-stage companies can – and do – generate outsized returns over time. But there is no guarantee any VCT will find enough winners to compensate for losing bets; still, in the meantime, tax-free income stream provides ongoing return.

The popularity of VCTs in recent years has prompted some concern that the government might choose to cut back on the tax benefits available. So far, however, the current Chancellor, Jeremy Hunt, does not appear minded to do so. Last autumn, he confirmed an announcement from his predecessor, Kwasi Kwarteng, that the lifetime of VCTs will be extended beyond 2025, when legislation enabling these funds is currently due to expire.

In the meantime, the more pressing deadline is 5 April; by then, advisers and their clients must decide whether they want to use their VCT allowance for the 2022-23 tax year – and if so, which of the crop of funds raising money this year they want to invest in. In theory, investors can put up to £200,000 a year into VCTs, though HMRC’s figures reveal that eight in 10 invest less than £50,000 – the average investment last year was £33,000.

For advisers and investors who do want to invest, it makes sense to select a fund (or funds) sooner rather than later. The demand for VCT shares is likely to be high once again this year, but supply is limited. The best funds are unlikely to remain open to investors right up until the end of the tax year.