VCTs and Budget 2015

Despite what you may have read to the contrary, the Chancellor’s changes to venture capital trusts (VCTs) in Wednesday’s Budget were not ‘tinkering’ or a ‘tightening of the rules’. Rather, George Osborne’s announcements were no more than what was required to ensure that VCTs do not fall foul of the European Commission’s rules on state aid. These limit the circumstances under which the governments of member states can use taxpayers’ money – either directly or through tax reliefs – to support private sector enterprises.

Financial advisers need not fear that VCTs are now in the Treasury’s firing line. Quite the opposite in fact – the determination of the Chancellor to ensure that the funds continue to comply with changing European regulation underlines his support for these closed-end funds.

Quite right too: VCTs have provided valuable support for growing businesses over the past two decades under both Labour and Conservative governments, as well as the coalition. The detailed rules have been amended several times, but since their launch, VCTs have raised more than £5bn from investors prepared to back small businesses looking for capital.

The new rules (which also apply to the enterprise investment scheme or EIS) in most circumstances restrict VCTs to investment in companies that are less than 12 years old and limit their investment in single companies to £15m, though a higher £20m cap applies for “knowledge-intensive” companies.

Meanwhile, another Budget change may actually give financial advisers more reason to consider using VCTs. The Government’s decision to reduce the lifetime allowance for private pension saving from £1.25m to £1m means many advisers may be looking for alternative tax-efficient savings vehicles for their wealthier clients. Individual savings accounts (ISAs) will play a role, but the £15,000 annual investment limit may not be enough to satisfy some investors, even if it rises in line with inflation.
VCTs, by contrast, have a maximum annual investment limit of £200,000 – almost generous enough to compensate for the lost lifetime allowance in a single tax year. The upfront tax break that the vehicles offer is not quite as attractive as what’s available to higher-rate taxpayers – as most VCT investors will be - from private pension schemes, in that you only get 30 per cent income tax relief on your initial investment. But investors do get the same tax-free income and capital gains on ongoing investments.

The flipside to these tax breaks is greater risk. It’s not only that VCT portfolios mostly consist of smaller businesses with relatively little track record, but also that investors must agree to hold on to their shares for five years in order not to forfeit their upfront tax relief. Plus this upfront relief is only available on investments in new VCT shares – not on secondary market purchases – so investors can’t put money into a fund with an established track record of performance.

So VCTs still won’t be suitable for all investors – but, overall, the budget has probably made the funds more rather than less attractive.