In this exclusive interview with Tax-Efficient Investment (TEI) Magazine, Peter Hicks, research analyst at Chelsea Financial Services, joins us to share his insights on VCTs.
Peter reveals how recent reforms have impacted the investor demand for VCTs and the ways in which he expects investors to change their perspectives. He also unpacks the biggest risks for investing looking to allocate to VCTs, along with highlighting a few companies who are particularly well-positioned.
TEI: From a top-down perspective, how have the reforms affected the attractiveness of VCTs?
PH: There’s no doubt that the attractiveness of VCTs has been negatively impacted by the reduction in tax relief. The 30% initial income tax relief was an excellent upfront incentive to invest, attracting growth capital towards some of the UK’s most innovative businesses.
Whilst the expanded qualifying rules are welcome, they risk being less effectively utilised in an environment of reduced fundraising, with potentially less capital chasing even more investment opportunities.
From an investor’s perspective, it’s always important to frame these changes as part of the wider UK investor landscape. The 20% relief now makes less sense to a higher-rate or additional-rate taxpayer, assuming they have available pension allowance.
Maximising pension allowances instead of making VCT investments means receiving more tax relief on contributions – at the marginal rate of tax – for far less risk. Of course, whilst pensions are a decent tax-efficient alternative for some investors, more capital flowing into SIPPs rather than VCTs represents a setback for UK venture capital.
It must be said that, unlike pensions, VCTs are 100% tax-free for dividends and capital returns. Currently, a pension is only tax-free upon crystallisation for up to 25% of the pot, with the maximum tax-free amount capped by the Lump Sum Allowance, currently £268,275. You also have to wait until you are old enough and ready enough to draw down from your pension.
Until then, pension tax relief is locked in, unlike a VCT, where holdings can be sold after five years and redeployed into another VCT offer for a further 20% income tax relief. Dividend Reinvestment Schemes can also provide a steady stream of further VCT investments that qualify for tax relief.
Of course, even with pensions – and pretty much everything else – we now fully understand that nothing is safe from poor government policy (SIPP IHT relief being removed from April 2027, for example, and Business Relief capped at £2.5m). It behoves politicians to better appreciate just how undermining these significant changes to investment wrappers, tax-efficient schemes and allowances can be. Judicious investment planning, conducted over years, can be rapidly upended by one afternoon’s Budget statement.
Nobody wins: investor trust is undermined, businesses receive less investment capital, and credibility is shattered for fear that a capricious government will keep moving – and narrowing – the goalposts every few years. Manufactured uncertainty from the Treasury is appallingly counterproductive.
All of this is a grievous blow to the British economy – a bitter pill for nearly everyone to swallow: for investors, managers and businesses, and, in the long run, the British taxpayer, who requires a growing economy to fund the public services they rely on. It is hard to see who actually benefits.
TEI: How do you expect investor demand to shift? Are we likely to see capital concentrate into fewer, larger VCTs?
PH: I hope I’m wrong; however, I expect significantly reduced fundraising this year. Even so, it’s likely many VCTs will continue to open as usual, but possibly with smaller fundraising targets and increased over-allotment facilities just in case demand materialises. The reduced demand, in my view, will narrow toward older, more established VCTs.
These VCTs typically have larger cash balances, greater liquidity, more established businesses and a proven track record to navigate harsher environments. The choice between a VCT of the aforementioned pedigree and a newer VCT starting out is obvious: why choose a newer VCT with less cash on hand to make new investments, support existing businesses and fund buybacks and dividends?
Again, I’m sorry to continually cast a pall over the sector, but this is ominous news for newer managers. Starting a new VCT can be very, very challenging, and thanks to the last Budget, it’s just got even harder. This is bad news for sector competition and investor choice, and bad news for young British businesses, who will have a smaller and less diverse pool of investment houses to partner with.
The ingrained advantage for older and more established VCTs is further compounded by the fact that the established players are actually in quite a good position to take advantage of the newer qualifying rules. This is positive news for their investors who participated in last tax year’s raise for 30% income tax relief; they’ve received the now extinct 30% tax relief and should enjoy the benefits of a broader investment universe.
TEI: In this new environment, what will cause certain VCTs to continue to outperform, and can you highlight a few strategies that are especially well-positioned under the new rules?
PH: The VCTs firmly in the camp of established managers ready to take advantage of the newer qualifying rules are British Smaller Companies, Albion VCTs, Northern VCTs, and Gresham House VCTs. The first three of these VCTs were fully subscribed last tax year, meaning they have the cash to invest in a broader investment universe as well as to support existing companies.
Gresham House had not intended to raise last tax year, having fully subscribed in the previous tax year, but decided upon a snap fundraise so investors could benefit from the 30% income tax relief while it lasted. They too have significant cash positions and are well placed to invest under the new rules.
TEI: What is the biggest risk that investors should be aware of when allocating to VCTs post-reform?
PH: This question very much ties in with the previous three. Firstly, the biggest risk has clearly been proven to be political. However, the hope now is that this risk is firmly behind us, and no further negative tinkering will occur in the foreseeable future.
Secondly, in an environment of reduced fundraising, cruel logic dictates that investors are incentivised to crowd around established, cash-liquid players. Investors should therefore be wary of VCTs with limited funds. One manager – of the previously mentioned established VCTs – remarked to me a few seasons ago that building their VCTs to a substantial AUM was, in part, a contingency against reduced tax reliefs or tax reliefs being removed altogether.
The manager was keen to place the VCT in a position where it could survive without the tax reliefs and a drastically reduced fundraising environment. This sort of foresight is typical of VCT managers, who spend a lot of time planning for different regulatory outcomes.
On a positive note, whilst the reduction in tax relief is disappointing, VCTs will remain tax-efficient investments. Dividends and capital gains will continue to be tax-free, and of course investors will still receive upfront income tax relief – albeit at the reduced 20% rate.
You can read this Q&A and more in ‘Reform, risk and opportunity: the new tax-efficient investment landscape‘, the latest issue of Tax-Efficient Investment (TEI) Magazine!
Peter Hicks
Peter Hicks joined Chelsea Financial Services in 2017. He graduated from the University of Edinburgh in 2013 with an MA in Ancient History, and also holds an MSc in International Business from the University of Dundee. Peter is responsible for VCTs and other tax efficient investments.
He also hold the IMC and diploma in Regulated Financial Planning.
