A venture capital trust (VCT) is an investment vehicle set up to invest in small, fledgling companies. These small companies are often, although by no means always, small startups needing capital to get off the ground and VCTs look to make money by providing the funding to grow and develop such companies.
There are strict regulatory and legislative rules surrounding how venture capital trusts work and just how they can invest your money. If they don’t follow these rules, they are unable to qualify as venture capital trusts and earn tax relief on your investment.
These rules were updated in 2012 to increase the size of the businesses you can invest in via a VCT, with the new rules meaning:
A major rule is that VCT investments must be made in companies with the objective to grow and develop. Another point is that there should also be a significant risk of loss of capital after allowing for tax relief, to prevent an emphasis on capital preservation.
While there are risks involved with venture capital trusts, which must be discussed with your adviser and clearly understood before you enter into such an investment, there is also the potential for rewards. These include:
The reason VCTs offer tax relief is to encourage people to invest in smaller, higher-risk companies requiring funds to get off the ground. These companies may find it difficult to raise funds because of the risk presented by their newness and small size, so the tax relief serves as an incentive to invest.
You receive tax relief at 30% on investments of up to £200,000 per year, meaning if you invest £10,000, you’ll get £3,000 back from the taxman. You only get to keep this tax rebate if you hold your VCT shares for at least 5 years.
When you invest in a VCT, you are pooling your funds with other investors. The venture capital trust itself will decide which companies to buy stakes in.
A venture capital trust is a listed company in its own right, so it’s important to note that if you invest in a VCT your shares are not in the companies the VCT has invested in but in the actual VCT itself.
By pooling your investments with those of other customers, VCTs allow you to spread the risk over a number of small companies, which can act to diversify your investment portfolio.
You can buy into a venture capital trust by subscribing to new shares when a new venture capital trust is launched or buying shares from other investors once the trust is already established and those investors are looking to sell.
Note that you won’t get the immediate upfront tax relief if you invest in existing VCT shares.
VCTs are complicated with risks attached, such as the risk of capital loss and the fact that your shares can be illiquid and hard to sell.
You need to ensure you understand these risks before purchasing shares in a VCT. An adviser is in the best position to explain these to you.
Jonathan Cooper
Senior Paraplanner at Drewberry
To receive VCT funds, a company must have a permanent establishment in the UK and carry out what HM Revenue & Customs (HMRC) deems a ‘qualifying trade’.
In practise this covers most trades, although there are exceptions that HMRC does not believe are in need of the additional financial support that VCTs can offer small firms. The sectors / businesses that are not eligible for VCT investment include:
If you choose to invest in a new venture capital trust, you’ll receive upfront tax relief of 30% on your investment. The maximum you can invest in a VCT in a single financial year is £200,000, although you can’t receive more in tax relief than your total income tax liability for that tax year.
In most cases, you only get to keep this tax relief if you hold your VCT shares for at least 5 years. (Two exceptions to this rule are if you sell the shares to your spouse or pass away within 5 years of the purchase.)
VCT shares bought on the secondary market — i.e. already-existing VCT shares you purchase — don’t get the upfront tax relief. However, they do count towards the £200,000 allowance for the tax year in which you buy them, despite the fact you don’t get the income tax break.
On investing in a VCT, you receive two certificates: a share certificate for the amount you’ve invested and a tax certificate that allows you to claim the 30% upfront income tax relief from HMRC.
Both are important documents that you should keep safe, as you’ll need the share certificate if you go on to sell your investment and the tax certificate to claim the tax relief.
If you pay tax under PAYE, then you have two options depending on the timing of the purchase. You can call HMRC and have your tax code adjusted immediately and start paying less tax each month. Alternatively, you can simply claim the income tax relief via your Self Assessment Income Tax form at the end of each tax year in which you’ve made an investment in a new VCT.
Jenny is a financial controller who has already maximised her ISA and pension contributions for this and all previous tax years. As such, she’s looking for other government-supported methods of reducing her income tax bill and is comfortable with investing in smaller UK companies with all the associated risks that involves.
Over 5 years of investing, Jenny could reduce her tax bill by £75,000. She could also adopt a cyclical approach, which would see her reinvesting the proceeds from year 1 in year 6, year 2 in year 7 and so on, claiming further tax relief each year, and all without investing more than the sales proceeds from her initial £250,000 stake.
This is a simplified example which assumes no loss or gain on the initial investments and does not take into account fees, charges or transaction costs. For more information on how this may work for you in principal, contact your adviser today.
You don’t pay capital gains tax (CGT) on profits from selling your VCT shares, regardless of how short a period you’ve held them, assuming the company maintains its VCT status.
It should be noted, however, that if your VCT investments make a loss, you can’t use this to reduce your CGT bill from other investments.
Dividends from investments in VCTs do not attract income tax provided the original investment was made within the permitted maximum of £200,000 per year.
Whether or not you should invest in a venture capital trust depends on your circumstances and your appetite for risk. There are other ways for high earners to reduce their tax bill which typically make more sense to consider first, such as ISAs and pensions. VCTs are high-risk investments and not for the faint of heart or those unable to withstand the potential for capital loss.
There are risks involved in investing in venture capital trusts as well as rewards, such as:
Venture capital trusts are complicated financial instruments which, by their very nature, must carry a notable risk of loss in order to qualify for the tax relief on offer from HMRC.
As such, we don’t recommend going it alone or purchasing through a stockbroker without advice — instead, use an adviser such as one of the team at Drewberry.
Please don’t hesitate to pop us a call on 02084327333 or email help@drewberry.co.uk.
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