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Enhance your investment portfolio

Discover more about Venture Capital Trusts and see if they are right for you

29 October 2021

5 minute read

Recent years have seen the popularity of VCTs rise substantially, but how can this vehicle create opportunity for your portfolio? Mike Romatowski, Wealth Planner, considers the VCT below.

What are VCTs?

First introduced in the Finance Act 1995, Venture Capital Trusts (VCTs) are specialist investment companies listed on the London Stock Exchange (LSE). Newly issued VCT shares come with generous tax incentives from the Government, designed to encourage investment in smaller UK companies. VCT investments aim to help small businesses grow, create employment and wealth and benefit the wider economy.

The Government backed VCT is a collective investment vehicle which invests in a spread of early-stage businesses and offers investors attractive tax reliefs (such as income tax relief of up to 30%).

Investors pool their money with other investors and a specialist fund manager invests this capital in qualifying businesses. These businesses must meet specific criteria on size, number of employees and the type of trade they undertake.

The fund manager builds up a portfolio of businesses, normally working closely with their boards to help them develop and remain on track. The ultimate goal for the fund manager is to successfully sell (or ‘exit’) these businesses, providing a return for investors (normally through an income tax free dividend).

Benefits of VCTs

Though VCTs are high risk, they can provide added diversification and opportunity to a portfolio, allowing investors to buy into young and exciting businesses to which they may not otherwise gain exposure. Additionally, as VCTs hold a range of different companies, they are internally diversified (thus spreading investment risk). On top of all that, investing in newly issued shares in a VCT can attract up to 30% income tax relief; on a maximum subscription of £200,000, that is £60,000 of potential income tax relief.

A growing number of our clients are asking us about VCTs and some have already reached out ahead of the upcoming ‘VCT season’. In our experience, clients are attracted to this vehicle for a variety of reasons, including (but not limited to)

  • A desire to further diversify their portfolio by investing in areas to which they have limited or no exposure
  • A desire to gain exposure to young, exciting and high risk businesses with the potential for total returns
  • A desire for income tax free cash flow via VCT dividends
  • Obtaining income tax relief

The last two points have become even more important given recent Government plans to increase the rate of tax on dividends.

Care should be taken to avoid allocating too much capital to such high risk investments, but for some investors the potential for total returns is attractive. There is a relationship between risk and reward, so it is possible that a VCT could perform well relative to less risky investments. Those with high incomes, appetite for risk and capacity for loss may find the risks acceptable due to the available reliefs and potential for a total return.

VCT tax relief examples

The tables below summarise the main incentives for VCT investors

Benefit

VCT

Rate of Income Tax Relief1

Up to 30%

Income Tax Free Dividends

Yes

Exempt from CGT on Disposal

Yes

Key Condition

VCT

Minimum Holding Period for Key Reliefs2

5 Years

Investment Limit Per Tax Year Per Investor

£200,000

Are VCTs Popular?

VCTs have become an increasingly popular tool for investors in recent years and this is something we have noticed amongst our clients. Some speculate the rise in popularity is linked with changes to pension contribution limits for high earners, though it is important to note that VCTs are not at all a substitute for pension contributions.

Though you could take our word for it, the numbers back up our experience. According to HMRC figures, between the 2006/07 tax year and the 2019/20 tax year (data for the 2020/21 tax year is not yet available at the time of writing), the amount raised under the VCT has increased by more than 2.5x3. With many speculating there could be further tax increases to help fund pandemic driven spending, we anticipate this demand will increase in the coming years.

How VCTs Work

VCTs are listed on the LSE. An investor can buy a previously owned VCT on the LSE, but this purchase will not entitle the investor to income tax relief. Instead, most investors buy new shares in VCTs directly from the VCT manager during a fundraising period, as newly issued shares enable income tax relief claims.

As the VCT is a collective fund, investors gain exposure to all of the underlying companies held within the VCT itself. There is no ‘normal’ number of underlying holdings, but many VCTs hold dozens of companies, helping to spread risk. When a VCT manager raises new funds, these funds are employed within the VCT to fund further investments (which could be into existing holdings or new businesses). As such, it is typical for the underlying makeup of the VCT to change over an investor’s period of ownership.

In terms of generating a return, VCTs do not typically focus on ‘capital gains’. This is because VCTs are capable of paying income tax free dividends. As such, when a portfolio company is sold, most VCT managers opt to pay dividends, rather than reinvesting the proceeds within the VCT (though they do have this option). This feature can be particularly helpful for those paying tax at higher rates or for those nearing retirement and looking for new sources of cash flow.

How to Sell VCT Shares

Though VCTs can be sold via the LSE (for instance, there is a ‘secondary market’ for VCTs), it is not a particularly active market as purchasers do not obtain income tax relief. As such, when an investor chooses to sell their VCT, they often find themselves selling back to the relevant VCT manager (usually at a discount). As income tax relief is lost on sales within five years’ of purchase, most VCT investors avoid selling their shares during this period.

Given the high risk nature of VCT qualifying businesses, VCTs are naturally tailored towards those who can tolerate high investment risk within a proportion of their investment portfolio. It may also suit those looking to support the long-term growth of early-stage businesses.

Disadvantages of VCTs

The high risk nature of small and young companies means that VCTs are high risk investments. There is a high probability that holdings within a VCT will fail and this could drag on returns and dividend payments.

It is important to remember that the favourable tax treatments afforded to these types of investments are there in part to counter the additional risks associated with investing in unquoted companies.

In order to qualify as a VCT, a company must be approved by HMRC. To obtain such approval it must satisfy a number of requirements imposed by HMRC. If the company fails to meet the ongoing qualifying requirements, this could result in adverse tax consequences for investors, including being required to repay the 30% income tax relief. Barclays does not guarantee HMRC approval of the companies.

How to Invest in VCTs

You may have read or been told that VCTs are ‘seasonal’; in fact, I mentioned the phrase ‘VCT season’ earlier in this article. This is generally true, as most VCTs typically raise funds between Q4 and Q1 the following year.

It is important to remember that not all VCTs are created equal. As with all investments, some VCTs are better than others and filtering through the options requires considerable due diligence. Barclays Wealth Management conducts thorough and rigorous analysis of VCT investments available in the market when establishing its panel of preferred VCT investments each tax year. We aim to identify long-established VCT managers that employ comprehensive due diligence processes and have demonstrated genuine skill in selecting investments over time.

If VCTs might be of interest to you, I strongly recommend speaking with your Wealth Manager now to register your interest. When VCTs opt to fundraise, they have a limit on subscriptions and this creates a limited window for investment. As we expect demand for VCTs to be high this tax year, we encourage you to begin discussions with your Wealth Manager now to ensure you do not miss out.

Next steps

If you would like to arrange a meeting with a Wealth Planner to discuss your options, please speak to your Wealth Manager.

Your Wealth Planner can help you understand the effect of tax on your wealth and offer tax-efficient wrappers for your investments. They’ll be able to guide you towards making the right decision for your financial planning needs. Your planner can't offer tax advice – you should seek that independently. Please bear in mind that tax rules can change in future and their effects on you will depend on your individual circumstances.

This article does not constitute personal financial, tax or legal advice. Each person’s circumstances are different so if you are unsure about investing, you should seek advice from a regulated adviser.

Things to consider

The value of investments can fall as well as rise. You may get back less than you originally invested.

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