More taxpayers are considering an investment in Venture Capital Trusts as a way to reduce their tax burden ahead of an expected increase in CGT in the Budget, says Bowmore Financial Planning.
Venture Capital Trusts (VCTs) are stock exchange listed funds that invest in small, innovative companies. VCTs benefit from two major tax reliefs – but you need to hold the shares for five years to benefit from them:
- Gains made on VCTs are exempt from Capital Gains Tax when you sell them
- Investors can claim 30% income tax relief on VCT investments – e.g. if you invest £100,000 you can reduce your income tax bill by £30,000
Bowmore says there are six things people considering VCTs need to know before they invest in them:
- Pick your VCT funds very carefully: There are almost 50 or so different VCT providers on the market with a 5 -year track record– but not all of them are good investments. You need to do a lot of reading, research and due diligence before you invest. Taking advice from a financial adviser is something you should consider.
- Pick a manager that consistently pays dividends: Dividends from VCTs are tax free and make up a big part of their appeal. You should look for managers that have a proven track record of consistently paying dividends – a 5% annual dividend yield is a good benchmark.
- Find a manager that knows how to exit an investment – and can prove it: The biggest driver of returns for VCT funds is profitable exits from their underlying investee companies. Only pick managers that can explain clearly and credibly what the plan is for exiting each of the companies in their fund – and can demonstrate that they have done this many times already.
- Only choose managers that will buy back your shares if needed: You should always plan to hold your shares in a VCT fund until it reaches the end of its lifespan – which will be at least five years. However, in an emergency you may need to sell them ahead of maturity. Selling them on the secondary market will likely lead to you taking a significant discount in value – so you should choose a manager that has a history of share buybakcs. You’ll still take a discount to value but you will get a better price from the manager than on the secondary market. If you sell your VCT before the 5-year period you lose the tax relief claimed at outset.
- Diversify – across manager, style and sector: If you invest in VCTs, you should look to diversify your holdings across at least three or four different funds. Those should each be managed by a different firm, invest with a different style and in different assets. For an example, there are lots of VCT funds investing in renewable energy but many of them are very similar – some will even invest in the exact same assets. Careless selection can end up with you taking more risk than necessary – so make sure you diversify properly.
- Invest in the autumn to get the widest selection: VCT providers for the most part open up for new investment between September and November each year. By Christmas most funds will be full and closed to new investment, especially the most popular funds. Don’t miss your opportunity!
Adam Canavan, Financial Planner at Bowmore, says: “If CGT does increase at the Budget we expect that VCTs will surge in popularity. VCTs can play an important role in tax planning strategies, but only if investors really do their due diligence.”
“The tax reliefs on VCT funds are very attractive, especially if capital gains and inheritance taxes are increased in the Budget. But it’s important not to let the tax tail wag the investment dog – you should only invest in a VCT fund once you have done your due diligence on the manager and the fund’s investments.”
Adam Canavan adds that there are several key differences between VCTs and the Government’s other tax-advantaged investment schemes, the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS):
- VCT investments are subject to Inheritance Tax, while EIS and SEIS investments are not
- Taxpayers can put capital gains made on previous investments into EIS and SEIS investments. They can then defer paying CGT on the previous investments until their EIS/SEIS shares are sold. This is not possible with VCTs
- Taxpayers can actually reduce the CGT bill on a previous investment by up to 50% by making an SEIS investment
