What are VCTs?
David Prosser reviews the benefits and tax advantages of VCTs.
In the run up to the end of the tax year on 5 April, all the talk in investment circles tends to be about individual savings accounts. But ISAs aren’t the only tax-efficient savings and investment allowance on offer from the government each tax year – venture capital trusts are another interesting opportunity.
VCTs are professionally managed collective investment companies that offer exposure to a portfolio of small, early-stage businesses. These are businesses not quoted on the stock market – and unlikely to be on your radar – that the VCT manager thinks have the potential to grow into far larger enterprises.
You will be familiar with some of the big winners from the VCT world over the past decade or so. Companies including Gousto, Zoopla, Secret Escapes, Five Guys and Everyman Cinemas all benefitted from VCT investment at an early stage of their development. Still, there have also been plenty of losers – the reality of backing young and immature businesses is that not all of them will succeed; some disappear altogether.
This risk profile explains why the tax advantages on VCTs are so generous; the government is keen to encourage investment in early-state businesses, so it offers incentives to help investors overcome their anxiety.
As long as you’re buying new VCT shares, as opposed to buying them on the stock market, you will qualify for 30% upfront tax relief.
David Prosser
As long as you’re buying new VCT shares, as opposed to buying them on the stock market, you will qualify for 30% upfront tax relief. A £10,000 investment, say, reduces your income tax bill for the year by £3,000. In addition, all income and growth generated by a VCT is tax-free. The former can be especially valuable in the current environment; many VCTs are structured to generate attractive dividends, which provides income for those looking to escape low interest rates.
Investors can put up to £200,000 into VCTs in any one tax year, ten times as much as the annual Isa allowance. Of course, that doesn’t mean you need to put anywhere near that much into the sector; data from HM Revenue & Customs reveals that the average VCT investment in the 2021-22 tax year was around £33,000.
However, if VCTs sound alluring, it’s important to be decisive. Since only new shares offer the 30% upfront relief, VCT managers issue new shares each year – either in existing funds or for new vehicles – in order to meet demand. But the size of these issues is limited, because managers don’t want to end up with piles of cash for which they can’t find good investment opportunities. As a result, VCT share issues, particularly from the most admired managers, often sell out before the end of the tax year. If you leave it to the last minute to decide which VCTs to invest in, you may miss out on the ones you want.
That’s not to suggest you should rush into a decision either. There’s no getting away from the fact that VCTs are more risky than many other investments. Managers are not allowed to invest in businesses that have more than 250 members of staff or assets of more than £15 million. To qualify, businesses also usually have to be less than seven years old. Many of these companies will fail to deliver.
The bet in a VCT is that the tax incentives will provide some cushion against the risk of investing in small businesses, and that some big winners will compensate for the losing investments. In practice, most investors will want to take independent advice on which managers and funds give you the best chance of being on the right side of that bet (and on whether VCTs are a suitable investment in the first place). Just don’t wait until the final days of the tax year to get started.
David Prosser
David is former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine. He writes regularly for the AIC.
