Venture capital trusts offer tax-free income and gains
David Prosser explains the tax benefits of these high-risk funds.
Time is running out if you want to take advantage of this tax year’s venture capital trust (VCT) allowance. While the 2024-25 tax year doesn’t end until midnight on 5 April, many VCTs are closing to new contributions a few days before the deadline. If you do want to invest, don’t leave it until the very last minute.
VCTs are collective investment funds that take stakes in small, early-stage companies. They’re not usually allowed to invest in a business that is more than seven years old, has more than £15m of assets or more than 250 full-time employees, though slightly more relaxed rules apply to so-called “knowledge-intensive” businesses.
The hope is that many of these fledgling firms will grow rapidly, giving VCT investors exposure to outsized returns, but there is also increased risk – early-stage businesses can (and regularly do) fail completely. To encourage investors to take that risk and to mitigate potential losses, the government offers a range of generous tax breaks on VCTs.
All income and capital gains generated by the funds are tax-free. In addition, as long as you’re buying new VCT shares, you get 30% upfront tax relief on your investment. This latter relief means a £10,000 investment will effectively cost you only £7,000.
You get 30% upfront tax relief on your investment.
David Prosser
It's never a good idea to invest simply to get a tax break. While the upfront tax relief in particular gives you some cushion against losses, you still need to be comfortable with the risk of losing a large chunk of your starting capital if the fund’s investments underperform.
You also need to be prepared to take a long-term view. For one thing, it may take a number of years for the VCT to reach a point where it can start selling successful businesses at a profit. Also, the rules of the scheme require you to repay your upfront tax relief if you sell your VCTs shares after less than five years.
Given this profile, most financial advisers will suggest you use other tax-efficient investment allowances, including your £20,000 individual savings account (ISA) allowance, before you start putting money into VCTs. Still, once you reach that point, VCTs offer more generous thresholds: you can invest up to £200,000 in a single tax year. That would cost you £140,000 after your income tax relief, assuming your income tax bill is high enough to offset in this way.
There is nothing to stop you spreading your money across more than one VCT, which can be a good way to diversify risk. For example, you might choose a core holding of a generalist VCT, which invests in businesses across a range of sectors, as well as several more specialist funds with a focused approach. Some VCTs also offer exposure to companies listed on the Alternative Investment Market, so you don’t have to stick to only privately-owned businesses.
It's worth noting that VCTs have become increasingly popular with income-focused investors in recent years. While the businesses in their portfolios don’t typically generate income – early-stage companies rarely pay dividends – VCT managers can structure the funds to offer yield paid for from capital gains. Tax-free distributions of, say, 5% a year look particularly attractive right now, with interest rates falling and other assets generating less yield.
Finally, remember that it’s always possible this or future governments will change the rules on VCTs. But in the Autumn, the Treasury committed to extending the scheme for ten years. And in the Spring Statement, the Chancellor has just set out detailed plans for discussions between the Treasury and “key stakeholders” in the VCT sector over how to enable a supportive environment for entrepreneurs in the UK. That bodes well for the sector’s future.
