Venture capital trusts get break they deserve

Amid the mounting anxiety about potentially tough Budget measures to come next month, it would be easy to overlook one piece of good news that has slipped out of the Treasury in recent days.

However, the announcement that venture capital trusts (VCTs) are to continue until at least 2035 should be warmly welcomed – VCTs provide investors with another interesting opportunity to save tax-efficiently.

First introduced in 1995, VCTs are structured as investment trusts and build portfolios of stakes in small, early stage businesses – mostly privately owned enterprises, though some companies listed on the Alternative Investment Market are eligible. Such businesses are more risky than established companies, with immature enterprises more prone to failure. But as compensation for accepting this risk, investors get a range of attractive tax incentives.

Most valuable of all, investors get 30% upfront tax relief on VCT investments of up to £200,000 a year. Subsequent dividend income and profits are free from both income and capital gains tax. There are certain caveats – for example, upfront relief is only available on new VCT shares, which must then be held for at least five years – but these are generous incentives nonetheless.

The important thing is not to get fixated on these tax reliefs. Invest in VCTs because you believe in the long-term potential of early-stage businesses, rather than simply to get a tax break. Given the extra risk these funds carry, they are better suited to those investors who have already built diversified portfolios of less risky assets – and probably to those who have already used their annual individual savings account tax-free allowance. But there is an opportunity to get exposure to exciting companies. Previous stars of VCT portfolios range from food delivery company Gousto to technology business Graphcore, and from property specialist Zoopla to online car dealer Cazoo.

Some funds inevitably perform better than others. Data from the adviser Wealth Club shows that over the 10 years to June 2024, the 10 largest generalist VCT managers actually underperformed the UK stock market as a whole, delivering an average return of 67% against 78% from the main market. But individual funds did much better and those numbers don’t take into account the impact of tax relief.
It's also critical to think about how you might use VCTs from a financial planning perspective.

If your saving is currently geared towards generating as large a capital sum as possible many years into the future, you have the option of reinvesting dividend income. Most VCTs are structured so these reinvestments go into new shares, qualifying you for upfront tax relief each time.
Alternatively, you may be more focused on income – perhaps because you’re managing assets for retirement. Early stage companies aren’t renowned for paying attractive dividends to shareholders – they’re typically reinvesting money they make to generate expansion and growth – but VCTs organise their portfolios so that some capital gains can be paid out as income. And this money is tax-free.
Overall, then, VCTs are an attractive long-term investment, with useful financial planning applications and a tax-efficient profile. They’re not for everyone, given the risk embedded in their portfolios, but they can work well for many people.

This is why the Treasury’s announcement is such good news. The extension of the VCT regime does not prevent the Chancellor from tweaking the tax treatment of the funds, but it’s good to know VCTs are going to be around for some time yet.