Could a VCT investment be for you?

Most people have heard of the more common type of investments - ISAs, Unit Trusts and Pensions, but there are other investments out there that could be a beneficial addition to an individual's portfolio. This article will explain what a VCT is, what it invests in, the risks associated with investing into one, and the benefit it could bring to an investor and their portfolio.

What is a VCT?

A Venture Capital Trust (VCT) is an investment company similar to an Investment Trust and quoted on the London Stock Exchange, which typically invests in unquoted shares. For example, a VCT may invest in the new shares of privately owned companies and the new shares of companies traded on the Alternative Investment market (AIM) or on the Off Exchange (OFEX). They are complex instruments, aimed at the wealthier, more sophisticated investor who:

• Wants to add diversity to their investment portfolio,

• Wants greater growth potential and is prepared to accept the greater risk associated with this type of investment, and:

• Has an income tax liability that will be reduced by investment in a VCT.

When you invest in a VCT, you become a shareholder of the trust, not of the individual companies in which the trust invests. This means you will get exposure not only to any new investments the VCT makes after you subscribe, but also to the VCT’s existing portfolio.

What does a VCT invest in?

There are different types of VCT, depending on their investment focus.

In general, most VCT’s will invest in small, entrepreneurial businesses in a wide variety of sectors, from early-stage tech companies to high-end niche manufacturers, retailers clothing brands and many more.

Some VCT-backed companies have gone on to become well-known household names, such as Zoopla and Gousto, some have achieved a listing on the London Stock Exchange and some have been sold to global brands, such as Microsoft, Amazon and Twitter.

Due to the nature of a VCT’s investments, they can potentially give you a high return, but they can also be much risker than larger, more established companies. In addition, shares within a VCT could be difficult to sell, which makes your investment more illiquid than most other products and should be considered a long term investment.

What are the tax incentives associated with investing in a VCT?

Investors can benefit from:

• Income Tax Relief - Up to 30% upfront income tax relief on the amount invested, provided shares are held for at least five years.

For a £10,000 investment in a VCT, £3,000 can be taken off an investor’s income tax bill – providing the amount of income tax claimed doesn’t exceed the amount of income tax due.

• No Capital Gains Tax - If VCT shares are sold for a profit, the proceeds won’t be liable for capital gains tax.

• No Income Tax on the dividend income - If a VCT pays dividends, there is no tax to pay, and dividends don’t need to be declared on a tax return.

To claim the upfront 30% income tax relief you will need to file a tax return and declare your VCT investment. This will result in either a lower income tax bill or a refund if you’ve already paid the tax.

Why are there tax incentives?

The UK Government introduced VCTs in 1995 as a way of encouraging people to invest into Britain’s exciting, entrepreneurial businesses. This more dynamic sector of the UK market comes with higher risks for investors. Smaller companies often struggle in their early years and have a higher failure rate than larger companies so to encourage investment into this area, the Government added attractive tax reliefs. This is because investments in smaller companies can fall or rise in value much more sharply than shares in larger, more established companies. They can also take longer and be more difficult to sell.

The continued support of a growing number of VCT investors is helping to fund even more UK smaller companies. According to the Association of Investment Companies, £542 million was invested in VCTs in the 2016/17 tax year, the highest amount invested for a decade, and at April 2017 the total amount invested in VCT’s stood at £3.9 billion. Many companies supported by VCT’s also benefit from having a representative of the investment manager on their board to provide expert insight and mentoring.

VCT money is helping to create jobs, reward innovation and bolster the UK economy. And to complete the circle, the VCT selling the shares it holds in successful underlying companies is good news for investors, as it means more potential for tax-free dividend payments.

Although VCT’s invest in unlisted or AIM-listed companies, VCT’s themselves are listed on the London Stock Exchange, and operate in a regulated environment. When investors purchase new VCT shares, they’re entitled to claim a range of tax incentives on investments up to £200,000 each year.

Why might you consider investing in a VCT?

• Portfolio diversification – VCT’s offer a unique opportunity to invest in a portfolio of early-stage companies, which offer the potential for high returns over an investment time horizon of five years or longer.

• If you face the risk of exceeding the pensions Lifetime Allowance – with the continued reduction to the pension’s Lifetime Allowance, many more people are now at risk of breaching this limit. VCT’s can offer a complementary way of planning for retirement in a tax-efficient manner.

• If you’re looking for additional sources of income - VCT dividends can potentially provide a source of regular tax-free income and don’t need to be declared on an investor’s tax return.

• If you have a significant Income Tax liability - Up to £200,000 can be invested in a VCT each tax year, with investors claiming up to 30% upfront income tax relief. That could be as much as £60,000 off a tax bill for wealthy individuals, providing shares are held for a minimum of five years. Income tax relief cannot exceed the amount of income tax due.

• If you’re a business owner looking to access cash held within your company but are concerned about the tax implications – VCT’s can help with planning a tax-efficient strategy to extract profit from a business. Business owners can take a dividend from their company and invest it into a VCT, with the upfront tax relief on the VCT being used to offset any dividend tax due.

• If you’re a pensioner looking for a way of drawing down your pension tax efficiently - the upfront tax relief available on a VCT investment can be used to offset the tax paid on pension drawdown, helping to make your pension even more tax efficient.

• If you’re an additional rate taxpayer, who will face your annual pension allowance being tapered down to £10,000 – the attractive tax benefits of a VCT could provide an extra way for additional rate taxpayers to invest tax efficiently for their future.

VCTs should be regarded as higher risk investments. VCTs are only suitable for UK resident taxpayers who can tolerate higher risk and have an investment horizon of more than 5 years.

Historical or current yields should not be considered a reliable indicator of future returns, which cannot be guaranteed. Share values and income from them may go down as well as up and you may not get back the amount originally invested. Owing to the nature of their underlying assets, VCTs are highly illiquid. Investors should be aware that they may have difficulty or be unable to realise their shares at levels close to that that reflect the value of the underlying assets.

The VCT tax benefits I’ve described in this document are correct at the time of writing. However, rates of tax, tax benefits and tax allowances do change. The availability of tax reliefs will depend on individual circumstances.

If you would like to discuss how a VCT could be of benefit to you, please contact me.

Charlotte Owen

Independent Financial Adviser

c.owen@grosvenorconsultancy.co.uk