Venture capital trusts (VCTs) were introduced by the Government in 1995 as a tax incentivised method of stimulating growth in the economy. VCTs are fully listed companies and their shares are traded on the London Stock Exchange. In many ways, they are similar in structure to an investment trust.
Who are the schemes appropriate for?
- are prepared to accept a high level of risk
- are prepared to accept the risks of crystallising a capital loss
- are happy to tie up capital for at least five years
- have a significant income tax liability (at least a 40% tax payer)
- have already used more mainstream tax-efficient investments, such as pensions and NISAs
- are unable to make any further pension contributions.
VCTs will invest in companies with a UK permanent establishment engaged in qualifying trades. There are a number of exclusions from a qualifying trade including property, financial services, commodities and, more recently, investment which benefit from feed-in tariffs or similar subsidies in the renewable energy sector.
There are strict limits on the size of investee companies, with gross assets limited to £15m immediately prior to the VCT investment and £16m immediately afterwards. The company must also have fewer than 250 employees at the time of the VCT investment and have raised no more than £5m aggregate from seed enterprise investment schemes (SEIS), enterprise investment schemes (EIS) and VCTs in the preceding 12-month period ending on the date of the investment.
Following changes to legislation in Autumn 2015, there is now a £12m lifetime cap on the total venture capital investment a company can receive (a £20m cap applies to knowledge intensive companies). In addition the number of employees permitted is increased to less than 500 for knowledge intensive companies.
VCTs attract three main tax benefits, all of which are available on new share purchases up to the maximum annual investment limit (£200,000).
- Income tax relief — individuals can receive a credit against income tax liability in the tax year of subscription up to 30% of the amount invested. This relief is conditional upon the minimum holding period of five years.
- Capital gains tax (CGT) exemption — any capital gain realised by the sale of shares in the approved VCT is not liable to CGT. However, losses are not allowable.
- Tax-free dividends — any dividend paid by the VCT to investors is not subject to income tax. Furthermore, the VCT itself does not pay corporation tax on portfolio gains and is therefore able to distribute the capital gains which it makes on an investment in a very tax-efficient manner.
While only new VCT shares will attract income tax relief on the initial investment, CGT exemption and tax-free dividends will apply to those VCTs purchased on the secondary market.
There are four categories of VCT.
- Generalist — These are genuine 'private equity' VCTs, managed by teams that have a track record of making successful development capital investments into expanding small companies and then realising the investment when the company is either floated or sold on.
- AIM — Some VCTs will purely invest in young, growing and entrepreneurial companies listed on the AIM market.
- Specialist — The term 'specialist' is usually applied to VCTs investing in technology, renewable energy, media or healthcare offering investors access to fund management teams with sector-specific expertise and industry knowledge.
- Limited life — These VCTs have the aim of protecting capital and returning funds to investors after the minimum holding period required to continue to benefit from tax relief.
As the VCT manager makes successful realisations, the management team may decide it is appropriate to pay a tax-free dividend to investors. In the early years, as the manager is deploying funds, it is unlikely many dividends will be paid but, over time, steady streams of dividends are then more likely, although clearly not guaranteed.
In addition to tax-free dividends, the manager may offer a share buy back facility to allow investors to exit after a period of time.
Investors should be aware of the following risk factors.
- VCTs are high-risk investments and you could lose a substantial proportion, or all, of your investment.
- VCTs predominantly invest in small companies where the risk of failure is high in the early years. You could lose a substantial proportion, or all of your investment.
- Investors should be prepared to tie capital up for a period of at least five years, and in some cases, potentially much longer.
- VCTs are listed and tradable on the London Stock Exchange but as no income tax relief applies to those shares purchased on the secondary market, should investors wish to sell the VCT shares, this may only be possible at a large discount to the net asset value.
- In the event of the VCT not investing 70% of its assets in qualifying trades within three years of commencement, qualifying status will be lost. This will result in the withdrawal of 30% income tax relief, which will have to be repaid by investors.
- The market for second hand VCT shares is limited and should you sell your shares, the price you achieve may be less than the value of the underlying assets.
We have taken great care to ensure the accuracy of this publication. However, the publication is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. © Smith & Williamson Holdings Limited 2016. code: 16/685 exp date: 15/02/2017