Why VCTs are still attractive
David Prosser explains the unique advantages still offered by venture capital trusts.
It’s been three months since the government’s cut to tax relief on venture capital trusts (VCTs) came into force, having been announced in November’s Budget, and there is a whiff of negativity about the sector.
Advisers who previously looked at VCTs as offering their clients a generous upfront tax incentive were understandably miffed to see that incentive reduced; some intermediaries may be wondering whether VCTs are still right for their clients.
Gains are free from capital gains tax – protecting investors from a tax where policymakers are increasingly interested in maximising revenues.
David Prosser
However, it will be a real shame if advisers turn their backs on VCTs en masse. It’s not just that the investment case for these funds remains interesting, though it genuinely does. VCTs also offer a really useful financial planning opportunity.
First the bad news. Since 6 April this year, the upfront income tax relief available on investments in new VCT shares has fallen from 30% to 20%. Previously, it cost investors £140,000 to invest the maximum £200,000 annual VCT subscription; now it costs £160,000.
Still, it’s worth saying that 20% remains a chunky incentive. Yes, the upfront tax relief has come down by a third, but investors are still getting a better deal than with, say, an individual savings account (ISA), where there’s no relief of this type available.
As for the positives, let’s start with the investment rationale. Remember, VCTs build portfolios of early-stage companies; managers look for businesses with exciting prospects and strong management teams then hope these acorns will one day turn into oak trees.
There are risks, of course. Some VCT investments will inevitably fail. But the gains on offer from big portfolio winners can compensate for these losses – it may only require a handful of big wins from the portfolio to deliver rewarding returns.
VCTs give investors an opportunity to participate at the smaller end of private markets, where exciting growth opportunities can be found. There is a growing recognition that stock market-listed companies – further along their growth journeys – may not be the place to find the most attractive opportunities today.
Nor should advisers overlook the financial planning attributes of VCTs. Gains are free from capital gains tax – protecting investors from a tax where policymakers are increasingly interested in maximising revenues. And, critically, VCTs also pay dividends that are completely tax free; that could be even more valuable.
Often, advisers and investors assume VCTs won’t generate much in the way of income – because early-stage companies are typically not yet in a position to make distributions to shareholders. However, VCT managers recognise the demand for income, and many therefore structure their funds in a way that enables them to convert portfolio gains into dividend payments. In many cases, VCTs make regular dividend payments to shareholders, offering yield that is completely tax-free.
For income-seeking investors – including those looking to supplement retirement income – this can be tremendously advantageous. Where an adviser has already made good use of a client’s ISA and private pension savings allowances, VCTs offer a further tax-efficient opportunity to generate yield. And there will hopefully be some additional long-term capital gains too.
All of which is to say that VCTs should not be discounted simply because of April’s tax changes. It seems certain the sector will raise less money in the 2026-27 tax year – that has been the experience following previous tax incentive reductions of this type – but there are many clients for whom the funds can still work well.
