VCTs have become even more risky over time too as the rules for what qualifies have become stricter, and larger more established companies have been excluded – along with those supported by subsidies.
If there’s a sensible place in your large and diverse portfolio for VCTs, they offer some impressive benefits, but if you invest purely for tax reasons, and don’t consider the risks involved carefully, you could be making an expensive mistake.”
What are VCTs?
Venture Capital Trusts (VCTs) are quoted private equity funds whose shares trade on the London stock market. The VCT aims to make money by investing in other companies. These are typically small companies which are looking for investment to help develop their business.
A VCT typically invests in around 20 businesses. These are chosen by the VCT manager – looking for opportunities amongst fledgling companies, and trying to negotiate attractive deals for investors. They have to be smaller and younger businesses in specific sectors in order to qualify.
There are a few common types of VCT: the generalists invest across different industries and sectors – although they’ll have a specific investment strategy to narrow down target companies; the specialists focus on specific sectors, which typically means even less diversification and higher risk; and AIM VCTs invest in new shares issued by AIM companies and tend to be easier to buy and sell. They will usually either run for the long term, or for a limited period – usually around the five year minimum allowed for VCTs – at which point they will sell out of the investments and distribute the money.
What are the tax perks?
When you invest you get income tax relief, up to a maximum of 30% of the amount invested (capped at £200,000 per tax year). This can be offset against income tax in the year you invest. If, for example, you invest £100,000 in a VCT, you’ll be able to cut your income tax bill by up to £30,000 in that year. However, the amount you can cut it by depends on your tax bill. So if in that year you only pay £15,000 in income tax, you could only reduce your tax bill by £15,000.
Any dividends are tax-free too, and any growth isn’t subject to capital gains tax. However, the rules on VCTs have changed in the past, so your tax benefits will depend on the investments within the VCT continuing to qualify if there are rule changes in future. You also need to hold the investment for five years to get the tax benefits.