What are venture capital trusts?
A venture capital trust, or VCT for short, is a tax efficient UK closed-end collective investment scheme that invests in small companies, either unquoted or trading on the AIM (formerly the Alternative Investment Market) with the intention of returning a profit to investors.
Venture capital trusts, which are generally themselves listed entities on the London Stock Exchange, were introduced by the government in April 1995 and were designed to encourage investors to invest directly in a range of small higher-risk companies whose shares are not listed on a recognised stock exchange.
Venture capital trusts can generally be separated into two different types: Limited Life and evergreen.
The pros of venture capital trusts
Income Tax reliefs
Exemption from Income Tax on dividends paid on ordinary shares in VCTs
Income tax relief of 30% on the value of new ordinary shares subscribed. This relief is available on investments up to £200,000 in a tax year.
All share must be held for at least five years or the Income tax relief received must be paid back. The shares must be new ordinary shares and must not carry any preferential rights or rights of redemption at any point in time within five years of the shares being issued.
Capital Gains Tax reliefs
You may not have to pay Capital Gains Tax on any gain you make when you dispose of your Venture Capital Trust shares (this is called disposal relief).
You can get two of the reliefs, dividend relief and Capital Gains Tax exemption, for both newly issued shares and second-hand shares acquired, for example, through the Stock Exchange. But Income Tax relief can be claimed only if you subscribe for new shares.
You can get Income Tax relief for a tax year if shares in VCTs for which you subscribed up to a maximum of £200,000 are issued to you in the year. A tax year begins on 6 April in one year and ends on the following 5 April. You can claim the reliefs, where applicable, from the Tax Office which deals with your tax affairs.
Spreading the risk
Venture capital trusts are run by fund managers who are usually members of larger investment groups. These professionals spread the risk of investing in early stage companies by investing in a portfolio on your behalf.
The downside to venture capital trusts
Costs Like all managed vehicles these trusts incur fees. Venture capital trust annual management fees tend to range between 2% to 3% per year. In addition to that, the initial charges for investing in a VCT are generally around 5% and, VCTs tend to charge around 2% for each investment that they make. You may have got 30% back in tax relief but nearly that same amount is eaten up in fees by the management team.
Holding period To keep your tax relief on a venture capital trust investment an investor must hold the shares for a minimum of 5 years. If the investment is a tax play then there are other vehicles, EIS and SEIS investments and EIS funds and SEIS funds with shorter, three-year holding periods.
Further, given that VCTs are listed on regulated stock exchanges, there will always be a temptation to get out should things be going well or if capital is required. Tax relief is also subject to change and is dependent on each individuals’ set of circumstances. They are also dependent on the VCT maintaining its VCT-qualifying status.
There were a number of rumours prior to the release of the 2017 Autumn Budget, that VCTs would be heavily penalised. This however, did not come to light in such an extreme manner, with one new measure being that from 6 April 2018, VCTs will be required to invest at least 30% of funds raised in qualifying holdings within 12 months after the end of the accounting period.
The changes do however ensure that VCTs will have to invest in higher risk areas in the market.
Alternatives to VCTs
We’ve brought together two alternatives to VCTs to give you a flavour of the differences.
VCT vs EIS funds An Enterprise Investment Scheme fund or EIS fund for short, is a managed investment vehicle that raises cash from individuals and institutions for the purpose of investing in a portfolio of EIS eligible ventures. EIS funds offer generous tax breaks including relief of 30% the amount invested off your tax bill. SyndicateRoom’s passive EIS fund, Fund Twenty8, is one such example. It is sector agnostic and offers a diversified portfolio of 28 investments in order to manage the risk of investing in early-stage equities.
SEIS funds A Seed Enterprise Investment Scheme fund, or SEIS fund for short, is a managed investment vehicle that raises cash from individuals and institutions for the purpose of investing in a portfolio of SEIS-eligible ventures. SEIS funds offer generous tax breaks including relief of 50% of the amount invested off your tax bill.