Talking tax

Are venture capital trusts set for a great leap forward as they celebrate a significant birthday? The first VCT came to market 25 years ago last month, as the brainchild of the then Chancellor Ken Clarke who wanted to find a way to support small businesses struggling to attract investment capital. VCTs were a niche interest back then, but appetite for the funds has grown and grown – and in a post Covid-19 economy they may be even more in demand.

Why so? Well, Rishi Sunak, Mr Clarke’s modern-day successor, is facing a financing crisis of his own. Having spent vast sums in response to the pandemic, he must begin to find ways to pay down the UK’s soaring national debt – and ideally ways that do not suck public spending or consumption out of the economy. A raid on tax relief on pension contributions is an obvious option. The pensions industry has worried for years that successive chancellors might withdraw higher-rate income tax relief on pension savings; Covid-19 might finally be the catalyst for this shift.

In which case, higher-rate taxpayers looking for the most tax-efficient options for long-term savings will need to look beyond pensions. VCTs, with the generous tax reliefs they offer, are a strong contender.

To remind you, investment in new VCT shares attracts 30% income tax relief upfront, though investors must hang on to their shares for at least five years to avoid being asked to repay the money. In addition, all income and capital gains on the funds comes free of tax charges.

It is worth pointing out too that VCTs have a generous annual investment allowance, with savers currently entitled to subscribe for up to £200,000 worth of VCT shares each year. That makes the maximum annual investment in private pensions, for most people capped at £40,000 or the saver’s annual earnings if these are lower, look pretty mean.

Indeed, the relatively low annual pension contribution allowances have already given VCTs a boost. Higher earners have for some time been subject to even smaller annual allowances – in some cases just £10,000 a year – and have looked further afield for tax-efficient savings opportunities. VCTs have been a clear beneficiary; in the 2019-20 tax year, new fund launches raised £619m from investors – roughly twice the total achieved a decade previously.

That growth may now be set to accelerate if the Chancellor takes an axe to pension allowances. This is not to suggest VCTs represent a get out of jail free card for higher-rate taxpayers. The funds come with certain risks – investment in small businesses, even those with exciting growth prospects, is by its very nature riskier than the type of investment that pension funds typically go for. The VCT sector has backed some big winners – Zoopla and Secret Escapes come to mind – but there have also been disappointments along the way.

Still, VCTs offer diversified exposure and access to specialist fund management skills, which reduces the risk that the funds pose. And the longevity of the sector means there is plenty of data to help investors make smart choices about which managers and funds to back.

One final thought. There’s another reason to think VCTs are set for some days in the sun. The generous yields on offer in the sector look even more attractive when you take into account their tax-free status. For those seeking yield in the current income drought, the sector may be tempting. Such investors are more likely to look at existing VCTs, which have portfolios mature enough to generate income, even though investing in the secondary market doesn’t net you upfront income tax relief. But this could nonetheless presage even more interest in the sector.