Investing tax-efficiently is the conundrum that finance professionals have been trying to master forever. One interesting avenue to engage in is a Venture Capitalist Trust (VCT). This article will analyse VCTs, looking at how they work and why they are so tax efficient.

What is a Venture Capital Trust?

Venture Capitalist Trusts were introduced by the government in 1995 in an attempt to incentivise investment into smaller private companies. This was previously lacking somewhat, due to the substantially increased risk involved in these investments as opposed to investments in larger publicly listed companies. In order to justify taking that risk, VCTs provide for significant tax relief for investors involved. There are a number of different types of VCTs:

  • Generalist VCTs invest in companies regardless of their sector in order to encourage diversification, thus reducing the risk involved.
  • Specialist VCTs are the opposite, focussing on a single sector.
  • Alternative Investment Market (AIM) VCTs focus on small companies who don’t yet fulfil the criteria to be on the London Stock Exchange.

How do Venture Capitalist Trusts work?

VCTs share many similarities to more traditional investment trusts in regard to how they function. It is important to note, however, that VCTs are companies themselves, listed on the stock market. This means that when investing, you aren’t investing in the smaller companies within the VCT, rather in the VCT itself. Further to this, there are set allowances which constrain investment abilities. The government limit on investment into VCTs is £200,000 per annum, with anything exceeding this amount not qualifying for tax benefits.

In terms of which companies will be included in a VCT, HMRC have a number of criteria to determine where your investment will go:

  • Companies must be a qualifying trade. This simply means that it must be conducted on a commercial basis, with the intention of realising profit, and cannot fall into the category of excluded activities. Excluded activities are simply ones that the treasury believes aren’t in need of any financial support.
  • Further, the underlying companies must typically have fewer than 250 full time employees, and gross assets of less than £15 million at the time of investment.
  • Finally, companies generally need to be young, normally those seven years or younger.

A number of famous companies have arisen with support from VCTs, for instance, Gousto, the recipe box delivery company and Zoopla, the property platform which has become a household name.

What tax relief can you get from them?

VCTs are a great form of tax-efficient investments. With these, you can get up to 30% income tax relief, meaning that with a £200,000 investment you can get relief on up to £60,000 per year. Further, with traditional dividends you are required to pay dividend tax on any returns earned that surpass the annual allowance of £1,000. Any dividends arising out of VCTs, however, are tax-free.

What are the risks of VCTs?

At the end of the day, VCTs are investments. This means that these can be volatile, and that by investing, your money is at risk. VCTs may however also come with more fund-specific risks. VCTs are characterised by the fact that they invest in smaller, younger companies. Often being start-ups, this comes with a number of potential pitfalls, with these companies having a much more likely to fail than larger, more established businesses.

There is also added risk when considering the fact that VCTs are a long-term investment. If you wish to keep the tax relief that is gained, you need to be prepared to stay invested in them for at least five years.

One way of mitigating some risk is to use a financial advisor. Our advisors are experts in this field and are ready and willing to help.

What are the pros and cons of Venture Capital Trusts?

Benefits of investing in VCTs:

  • They are incredibly tax efficient. As mentioned above, you can get a significant amount of tax relief on then, as well as tax-free dividends.
  • The companies within them have much higher potential for growth than other firms. Being small start-ups, there is a potential of them flourishing at a much higher rate than already-established companies.

Drawbacks of investing in VCTs:

  • Risk, as mentioned above, is a significant con. The companies in the fund will tend to be much more volatile and have a much higher risk of failure, which makes them a much more unpredictable choice.
  • VCTs require a long-term commitment if you want to enjoy all of the tax advantages. This, when coupled with the risk, requires a lot of consideration.
  • VCTs tend to be illiquid. This means that they can’t necessarily be easily sold for cash without any loss of value.

Conclusion

Thus, Venture Capitalist Trusts are a very attractive prospect from a tax-efficient investment standpoint. They allow for significant tax relief, tax free dividends, as well as giving start-up companies the push they need to enter into fruition. Nevertheless, this doesn’t come without challenges. VCTs can often be very risky, especially since start-up companies in their early years cannot guarantee the same returns and prospects as larger publicly listed companies. VCTs do aim to mitigate their risk as much as possible, for instance through diversification, yet the risk will always be significantly higher than with more traditional investment models. The likely benefits are substantial, yet it is important to keep the possible shortfalls in mind.

Talk to one of our expert financial advisors today

Disclaimer: Capital is at risk and you may lose all your money. These are high-risk investments are you are unlikely to be protected if something goes wrong. The value of an investment, and any income from it can fall as well as rise and investors may not get back the full amount they invest. Venture Capital Trusts (“VCTs”) should be considered longer-term investments and may be higher risk and more difficult to realise than an investment in listed securities. Tax reliefs are dependent on the VCT maintaining its qualifying status and on investors’ individual circumstances. Current tax rules are subject to change. If a VCT loses its qualifying status, tax advantages will be withdrawn from that point. VCTs usually trade at a discount to their net asset value.

The content provided by First Sentinel Wealth is not a personal recommendation for VCTs and you should ask your adviser for professional advice to determine if a VCT is appropriate and suitable for your personal circumstances.

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