Venture Capital Trusts (VCTs) have become popular not only among business owners and entrepreneurs looking to raise finance, but they have also become attractive propositions for high-net-worth individuals looking for tax-advantageous investments to boost their portfolios.
The UK has become one of the world’s most successful markets for entrepreneurial small companies and there’s no doubt that VCTs have played an important part in this. In the 2021-22 tax year, VCTs raised £1.13bn1 to be invested in small and innovative UK companies.
VCTs have made more than 1,000 investments totalling £1.7bn into 530 small and medium-sized companies in the past five years2., which is testament to their increasing popularity.
VCTs are investment funds designed to provide capital to small, unquoted companies and some quoted (such as on AIM) with high growth potential. VCTs were established in 1995 to encourage investment in early-stage firms which typically struggle to raise capital. The rationale is that their existence promotes innovation amongst the small higher-risk business community, which in turn drives up productivity, creates jobs and boosts economic growth.
VCTs typically target companies that have the potential to achieve high growth and generate significant returns for investors. However, such companies are typically at an early stage of development and therefore are considered high-risk investments.
A valuable supplement to your investment and retirement planning
Pensions tax relief has become less generous over the years. The recent Spring Budget included some changes relating to pensions, making them potentially more attractive from a tax and saving point of view depending on an individual’s personal circumstances.
- The annual pension contribution allowance is increasing from £40,000 a year to £60,000 a year. Previously, high earners could only contribute a maximum of £4,000 a year and this is increasing to £10,000 a year.
- The Budget is also abolishing the Lifetime Allowance, ending the restrictions on those trying to save for retirement.
- The maximum tax-free lump sum an individual can take from their pension is limited to 25% of the current £1,073,100 Lifetime Allowance. However, individuals with protection arrangements in place may be entitled to take a larger tax-free lump sum.
Investors who are thinking about their long-term retirement plans should consider VCTs as complementary to existing pension arrangements.
VCT tax reliefs for investors
The main tax benefits of investing in a VCT include:
- Income Tax relief – investors can claim upfront Income Tax relief of up to 30% on the amount invested in a VCT, subject to certain conditions. The investment must be in a new VCT (or new shares from an existing VCT), be held for five years, and the investment cannot exceed £200,000 per tax year.
- Tax-free dividends – dividends paid by VCTs are generally tax free, this can be especially useful for income in retirement.
- Capital Gains Tax (CGT) exemption – any capital gains made on the sale of VCT shares are generally exempt from Capital Gains Tax, provided that the investor has held the shares for at least five years.
We’re here to help
We have explained why it could be useful to invest in VCTs, but it is important to note it is a complex process and only suitable for those willing to take a high level of risk.
In addition, investing in small companies can be risky, so it is essential to carefully consider the investment proposition fully before investing in a VCT.
And it is certainly not suitable for all investors due to the underlying illiquidity, the early-stage nature of the investments and the need to hold the investment for a significant period for tax reasons.
There is also a significant risk of capital loss and there may be no market for the shares should you wish to dispose of them. This is where our specialist advice can help to determine how VCTs may be appropriate for you. We would be delighted to discuss any aspect of investing with you, so please don’t hesitate to get in touch.
The contents of the article have been prepared solely for information purposes. The article contains information on financial products and services and such information is designed for and addressed solely to individuals seeking generic industry information. Past performance is no guide to future returns. The above content does not represent a personal recommendation. Taxation will depend on your individual circumstances and may be subject to change.
- 1AIC April 2022
- 2AIC October 2022