What Are Venture Capital Trusts?

Written by Karen Bryan

twentypoundnotetopsIf you are looking for an investment which offers tax breaks and the potential of high returns, then Venture Capital Trusts (VCTs) are worth investigating.

VCTs were introduced in the UK in April 1995 to encourage indirect investment by individuals in fledging high-risk companies.  The VCT makes investments in small companies which are not listed on the stock market, have fewer than 250 employees and have assets of less than £15 million. VCTs spread the risk by investing in several companies.

Investors buy shares in the VCT. There are different types of VCTs; Generalist, which invest a wide range of sectors, Specialist, which focus on one sector and AIM, which invest in companies due to list or already listed on the Alternative Investment Market.

Tax Benefits of VCTs

Income Tax relief of 30% is available on a VCT investment of up to £200,000 in the current tax year. This means that if you invest the full £200,000, you will be able to claim a tax rebate of £60,000.  However, you must hold the investment for at least five years to benefit from this tax break. Some VCTs are designed to be dissolved after five years, allowing investors to liquidate their holdings as soon as the income tax relief is locked in.

There is no Income Tax payable on company dividends.

There is no Capital Gains Tax payable on the proceeds from the sale of ordinary shares in a VCT.

Risks of VCTs

The value of the VCTs could drop if some of the companies in which investment has been made do badly.

The price of shares is likely to be reduced in order to attract second-hand buyers, who don’t enjoy any of the tax advantages enjoyed by shareholders who subscribed directly to shares initially issued by a VCT.

There is an initial charge of between 3 – 5% when you purchase shares in a VCT. Some brokers will refund part or all of this charge to customers. There’s also likely to be an annual management charge.

A Good Time to Invest in VCTs?

As the signs of UK economic recovery increase, is this a good time to invest in VCTs in order to fund the success stories of tomorrow? Whilst continuing low interest rates on savings, contrasted with the tax breaks and potential returns on VCTs, may make VCTs look alluring, I doubt if they are suited to most people.

In my opinion, it’s probably better to use your full income tax breaks available on paying into a personal pension (tax relief on annual earnings up to £40,,000 from April 2014) and investing in Stocks and Shares ISAs (an annual allowance of £11,880 from April 2014) before considering VCTs. The Income Tax free dividends and Capital Gains Tax exemptions on VCTs are of most benefit to higher rate tax payers.

This article is based on my personal research and understanding of VCTs. It’s advisable to consult an independent financial adviser before investing in VCTs.