For more than 25 years, Venture Capital Trusts (VCTs) have been an essential part of the UK economy and have supported many of the UK’s Small and Medium Enterprises (SMEs). Since their introduction in 1995, over £8bn has been provided to support these critical businesses.
2021 was no doubt the best year yet for VCTs with exposure to sectors and companies that did well such as tech, e-commerce, healthcare, video games.
According to the latest government statistics, £668m of VCT shares were issued in 2020/21, which is up 4% from a year earlier and almost double the amount raised in 2009/10.
Are these trends set to continue?
We’ll begin looking at what a VCT actually is. A VCT is a company that subscribes for shares in, or lends money to, small unquoted companies ie those which are not listed on the London Stock Exchange.
Investment first, tax second
Changes in tax rules are a key part of the investment decision for VCT investors.
You can qualify for income tax relief, up to a maximum of 30% of the amount invested (the maximum is £200,000 per tax year) which can be offset against income tax in the year you invest.
Tax dividends in VCTs are tax free. In the current tax year it’s expected that VCT investments could be boosted further as investors shelter their money from the dividend tax rises of 1.25% announced in September last year. This will apply to dividends received on or after 6 April 2022.
For these tax reliefs to apply, subscribers must be aged at least 18 and qualifying shares must be retained for a minimum holding period of five years. Income tax relief is given by a reduction in the tax liability for the tax year in which the investment is made.
Falling pension allowances
Demand for VCT investment is also driven by falling pension allowances. When pension allowances get less generous, those with higher incomes and large pensions start to look elsewhere for tax relief. They came close to record highs between 2017 and 2019, when the pension lifetime allowance dropped from £1.25 million to £1 million.
Don’t forget ESG aspects
Increasingly the ESG aspects of VCTs are a key factor, along with tax incentives, for investors. For investors looking for positive impact opportunities, VCTs and the Enterprise Investment Scheme (EIS) are potentially attractive options.
Fund Managers of some of the larger VCTs say that ESG considerations are an important factor in making and managing VCT investments, and in the way that they interact with portfolio companies so that they ensure they behave responsibly towards the environment and society.
Investing in such businesses does not always have to mean a greater level of risk. Different VCTs pursue different investment strategies, with the most discerning looking at which companies have already achieved some form of market validation.
Notwithstanding specific reasons to invest, investors use VCTs as part of their tax planning and they can also be a valuable and complementary addition to an investor’s general portfolio.
Its likely that this year VCTs will continue to grow in popularity due to people looking to shield their wealth from taxation, greater restrictions on pension allowances for higher earners and the tax-free dividends that VCTs generate.
However, VCTs are quoted private equity funds that buy early stage private companies, which is a high-risk approach. Its always worth getting some financial advice from the experts to fully understand all the risks.
Feel free to get in touch if you would like further advice on investing in VCTs for your investment portfolio and retirement.