Venture Capital Trusts (VCTs) have become increasingly popular since their inception in 1995, with the tax-efficient investment vehicles experiencing a bumper year in 2021/22.
Figures published in FTAdviser show that £1.13 billion was invested in VCTs last tax year, a remarkable 63% increase from 2020/21.
All this interest in VCTs may leave you wondering whether they could be a good investment option for you.
So, find out what VCTs are, the tax benefits they offer, and the risks they may pose to your portfolio.
Investing in “ground-floor” companies
A VCT is essentially a package of early-stage businesses seeking funding to help them grow, expand, and cement themselves in the UK’s business landscape.
You invest in a VCT by buying shares in it, much like buying units in a fund. These shares then rise and fall in value, depending on the performance of the businesses within the trust.
Crucially, VCTs have set windows for when they accept investment. This can see some VCTs reach their goals and stop taking funds quickly, such as for the Amati AIM VCT, which raised £25 million in just five days during February 2022.
These investment thresholds can sometimes be increased if demand is particularly high, too. For example, the Octopus Investments AIM VCTs extended fundraising from £30 million to £40 million in August 2021 to account for investor interest.
It’s important to be vigilant and aware of when VCTs are gathering new monies, as you may otherwise miss out.
Sometimes, companies within the VCTs that benefit from this funding do expand and become household names. For example, second-hand fashion platform Depop benefited from VCT investment.
Similarly, online car retailer Cazoo also received VCT funding on its way to becoming a recognisable brand in the UK.
VCT investments do carry additional risk
Of course, while companies such as Cazoo and Depop managed to build on VCT funding and find success in the marketplace, many other companies contained within the packages do not.
Smaller businesses are notoriously more volatile, as their value can swing dramatically in response to both market conditions and their own internal performance.
That can see the value of VCT shares fluctuate far more than investments in bigger companies.
Furthermore, many of these companies will ultimately fail entirely. As a result, VCTs can also present greater risk of you losing your entire investment, as there’s a higher chance that the companies will fail than established businesses will.
VCT investments are also fairly illiquid, as it can be harder to find buyers for your shares. You’ll need to be comfortable with the fact that you may have to hold your investment for an extended period if you’re unable to sell it, and that you may not be able to access the invested money until that time.
Generous tax benefits in return for the risk
In return for the additional risk you take on when investing in smaller companies through VCTs, the government offers some attractive tax benefits to encourage investment in them.
Most notably, these benefits include:
– Up to 30% Income Tax relief on up to £200,000 of investment. That means you could reduce your Income Tax bill by up to £60,000 if you made maximum use of the available VCT tax relief.
– No Capital Gains Tax (CGT) due on any profits derived from VCT investments. That means you’ll be able to sell your VCT shares without having to pay a CGT bill on any profits.
– Tax-free dividends from increases in the VCT’s value. This can offer an alternative source of income from VCTs, rather than having to sell your shares to make a profit. This is especially valuable since the hike in Dividend Tax that came into effect on 6 April 2022.
These tax-efficient benefits could see a VCT investment play a useful role as part of a diversified investment portfolio.
Of course, it’s important to weigh these benefits up against the additional risk you’ll have to take on. You should only invest in VCTs if it suits your personal circumstances and attitude towards risk.
Important rules to note with VCTs
As with any tax-efficient investment in the UK, there are a few key rules that you must comply with to continue to benefit from the advantages that VCTs offer.
Firstly, you’ll need to hold your investment for at least five years to continue qualifying for tax relief. That means you will need to be comfortable with taking on the greater risk that VCTs can present in the medium to long term.
Additionally, your investment must retain VCT-qualifying status, too. This will largely be down to the VCT provider you choose, so make sure you choose a reputable business that complies with VCT rules and regulations.
Tax rules may also change in future, and so VCTs may not always be as favourable for tax as they are currently.
Speak to us
If you’d like to find out more about how VCTs could be a useful, tax-efficient addition to your investment portfolio, please speak to us at Cordiner Wealth.
Email email@example.com or call 0113 262 1242 to find out how we could help you.
Venture Capital Trusts (VCT) are higher-risk investments. They are typically suitable for UK-resident taxpayers who are able to tolerate increased levels of risk and are looking to invest for five years or more. Historical or current yields should not be considered a reliable indicator of future returns as they cannot be guaranteed.