The government has recently confirmed that the venture capital trust scheme is being extended to 2035, providing another 10 years of certainty for financial advisers who use the tax-advantaged vehicles for their clients.
This puts VCTs on track to celebrate their 30th birthday next year, since the scheme was created in 1995.
But what are VCTs? How do they work, who are they intended for, and why would you use them?
A VCT is a company listed on the London Stock Exchange that invests in other companies. In that respect, it is just like an investment trust.
However, there is an important difference – and the clue is in the name. While an investment trust can invest in almost anything, VCTs invest in young, up-and-coming UK companies that are either unlisted or listed on the Alternative Investment Market (Aim).
These businesses are classic 'venture capital' investments in that they are small (with a maximum £15mn of assets) and early-stage (usually less than seven years old at the time of investment).
To motivate Joe Public to invest in VCTs, the government offers some generous tax benefits. The most eye-catching is 30 per cent upfront income tax relief. So, invest £10,000 in VCTs and get £3,000 off your tax bill that same year. You can invest up to £200,000 in VCTs each year and receive the 30 per cent relief, provided you have sufficient income tax liability to set against it.
There is one catch: you have to hold the VCT shares for five years or the relief is clawed back.
The other tax reliefs are tax-free dividends, which are significant as VCTs tend to target a 5 per cent yield, and tax-exempt capital gains. These reliefs do not depend on the five-year holding period.
Who are VCTs for?
I made a flippant reference to Joe Public earlier, but the point behind it was that anyone can invest in VCTs. You do not need to be high net worth, or sophisticated. VCTs are not 'non-mainstream pooled investments'. But of course, that does not mean that VCTs will be suitable for everybody.
To start off with, you need to have sufficient income tax liability to make the 30 per cent upfront relief worthwhile. The typical VCT investor will have exhausted other tax-efficient vehicles, such as Isas and pensions, and is likely to be a high earner.
Fairly obviously, a VCT investor also needs some tolerance for risk and capacity for loss. Though the 30 per cent tax relief dampens the maximum loss to just 70p in the pound – and no VCT has ever done that badly – we are dealing with small, early-stage UK companies. Let’s be in no doubt that these are high-risk investments.
A few things mitigate that risk, apart from the tax relief. The most important is that a VCT is a portfolio of investments – a fund, in other words. A typical VCT might invest in 30 to 50 companies, and while some of these investments might result in a total loss, it is unlikely they all will.
