Utilise tax relief by investing in small UK companies
Venture Capital Trust (VCT)
What is a Venture Capital Trust?
A VCT is a listed company which collects money from investors and uses it to buy stakes in VCT-qualifying, privately owned companies. Investors subscribe for shares in a VCT which then invests in qualifying trading companies, providing them with funds and (hopefully) helping them to grow.
The Venture Capital Trust (VCT) scheme was introduced in 1995 by the UK government to encourage investors to indirectly invest in a range of unquoted, smaller (higher risk), trading companies.
It’s a Venture Capital Scheme (VCS) alongside the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS).
Investors are entitled to tax incentives on investments up to £200,000 a year. For example, you get 30% income tax relief on investments where your VCT share has been held for at least five years, your capital gains are tax-free, and, if your VCT pays dividends they will be tax-free too.
Established VCTs can offer an attractive way to gain exposure to a sector of smaller, VCT-qualifying companies that are not listed on the London Stock Exchange but have the potential to grow faster than larger, listed companies.
What are the potential risks?
VCT investments can be unpredictable as you buy shares in smaller companies often not listed on the London Stock Exchange, with their value often rising and falling more often than larger, more established companies. They can therefore be more suited to investors comfortable with high risk.
It is also important to note that tax relief is never guaranteed. And, if you decide to sell your shares before the minimum of 5 years, you will have to repay any income tax relief claimed to HMRC.
First Wealth often recommend VCTs for business owners with substantial income who are looking for ways to reduce their tax burden.
VCTs are only suitable for UK resident taxpayers with an appetite for risk and a time horizon greater than five years. And, since VCTs are a higher-risk investment, they should only be considered as an addition to a well-diversified portfolio of other investments, such as pension savings and ISAs.
Because of the nature of underlying assets in VCTs, they are highly illiquid. While there are regular windows when you can sell your shares, they only come around three or four times a year. So, unlike with other equity investments, you can’t release capital whenever you need to. You may therefore experience difficulty in, or be unable to, realise your shares when you want to.
Tax levels and reliefs may also change, and the availability of tax reliefs will depend on individual circumstances.
There are three different types of VCT: generalist, AIM, and specialist.
Generalist VCTs invest in a wide range of small, usually private companies in a range of sectors, and tend to be the most common. They usually offer investors diversification across many early-stage companies, and fund managers will often actively work with businesses to help them grow and succeed. VCTs often look to back established entrepreneurs and some target particular types of company or sectors.
AIM VCTs invest in new shares issued by AIM-listed companies and target tax-free growth as well as income. Because these VCTs are investing in listed firms, the price can be more volatile. This is because the underlying companies are constantly being valued by the stock market rather than assessed periodically, as with unlisted businesses. However, since ordinary shares are more easily sold on the market, the increase in volatility comes with a little more flexibility for investors to enter or exit investments.
There are also specialist VCTs which focus on just one sector.
You may also see some rare hybrid trusts which invest in both generalist and AIM companies.
You can invest in a Venture Capital Trust by applying for shares when a VCT is open for new investments (where you will read the new share offer prospectus, complete an application form, and send a cheque or electronic payment).
You can also invest through a financial adviser. Because VCTs are high-risk investments, we will always advise that you speak with a Chartered Financial Adviser.
When claiming tax reliefs on your VCT investments, you can claim on a maximum annual amount of £200,000.
To claim tax relief on your VCT investments, you must complete the Additional Information (SA101) pages. Your accountant can help you to do this.
You will not get tax relief on your VCT investments if:
You buy the shares on the secondary market (you will get no income tax relief)
You sell the investment within five years of buying (you must give back the 30% tax relief you previously received).
In some respects, an EIS and a VCT are similar. Both offer 30% upfront income tax relief to investors – you can claim 30% of the value of your investment off your income tax bill (provided you keep your shares for at least 3-5 years respectively). And. both EIS and VCTs offer tax-free growth.
Though they are definitely different. VCTs typically don’t hold on to growth and gains but instead distribute gains to shareholders as dividends, but EIS companies rarely pay dividends (and if they do, they are not tax-free, unlike VCTs). In addition to this, the two have different minimum holding periods (VCTs have a period of at least 5 years, while EIS has a minimum of 3. There are also maximum amounts upon which an investor can claim tax relief each tax year. These are £1 million for an EIS, and £200,000 for a VCT.
One of the biggest differences is that VCT investments are illiquid and can therefore be hard to sell (this is why many opt for VCT providers which offer a ‘buy back’). They are also considered higher risk because you are investing in smaller, unquoted, companies (though this can also be a positive as you may get higher returns). And,you are usually invested in less companies than you may be with other vehicles – this is referred to as ‘concentration risk’ as your investment funds are concentrated in a smaller area.
When making VCT investments, there are a number of risks to consider:
They are illiquid and can therefore be hard to sell.
Investing in smaller, unquoted, companies is considered ‘high’ risk in relation to potential losses.
VCT investments have a concentration risk because they invest in a smaller pool.
They are not covered by the Financial Services Compensation Scheme.
This is provider–specific, but it is usually £3,000 minimum.
There is a minimum investment duration of five yearsand no maximum duration.
Because the dividends received from VCT investments are already tax free and CGT free when sold, you wouldn’t hold VCTs within an ISA or SIPP. Instead, you’dlikely hold something that is usually taxed, in order to make the most of ISA and SIPP tax efficiency.
Yes, though these can vary.
There is an initial fee charged anywhere from 1% to 5%. An average annual management charge anywhere from 2% to 3 %. And a performance fee from 15% to 20% (though this fee is only applicable if the investment reaches a specified, and agreed upon, level of performance).
When you invest in a VCT, you will be given a certificate to use which will reduce your income tax. When it comes to claiming, you will need this certificate when liaising with HMRC or your accountant.
The dividends you receive from your VCT, on the other hand, are automatically tax free. And you do not need to claim anything for CGT.
There are several restrictions placed on who can invest in VCTs. First, you must be liable to some kind of UK income tax – otherwise you will not receive the tax benefits associated with the investment.
A good financial planner will also restrict VCTs to those with an appetite and capacity for loss due to their high-risk nature.
Book a video call
Interested in becoming a client? Book a 30-minute video call and we'll answer your questions.
News and insights straight to your inbox. Subscribe to our newsletter.
You are now leaving First Wealth's website
First Wealth (London) Limited does not endorse the linked website or any of its contents, and is not responsible for the accuracy of the information contained within it.