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Aiming for tax relief

I have noticed a good deal of publicity surrounding venture capital trusts and am particularly attracted by the availability of tax relief. However, I have also heard they are risky forms of investment. Can you outline the tax advantages and comment on their suitability for a private investor?

The most important aspect of any investment strategy is to achieve a balance of holdings that fit together as one coherent plan to achieve an individual&#39s personal objectives. This means ensuring the investor understands the nature of the underlying investments before looking at the tax incentives that accompany them.

Sadly, as can be seen with Isas, the tax advantages are often given prominence in the promotional material and advertisements. But the tax wrapper can conceal the contents and should always be considered as secondary.

Venture capital trusts are similar to investment trusts in that they are companies which invest in other companies. They first appeared in 1995 and their distinguishing feature is that the underlying investments are used to finance unquoted companies, including companies listed on the Alternative Investment Market.

By its very nature, venture capital is a speculative investment. At such an early stage in a company&#39s development, it is difficult to assess its chances of success. VCT managers are specialists who will consider perhaps several hundred propositions before selecting those which fall within the criteria specified in the trust document.

The types of company targeted will be specified at outset to allow investors a choice of the most appropriate portfolio. As each VCT may invest in 30 to 40 companies, investors may choose to spread the capital earmarked for this area of investment over, say, three VCTs with differing objectives so that the underlying spread is over up to 120 companies. You will appreciate that the reduction in risk is significant.

The VCT manager&#39s task is to support young companies with a potential for significant growth. They will no doubt refuse some that will go on to be spectacularly successful as well as choose some that will fail. But their task is to ensure they choose more gold than lead.

VCT investments are long term and will reward patience but should only be considered as a part of an overall strategy.

To offset the unquestionable risk associated with investing in young and relatively new companies, the rules governing VCTs impose obligations in return for favourable tax incentives.

To qualify, the VCT must be approved by the Inland Revenue and quoted on the London Stock Exchange. It must invest at least 70 per cent of its funds in qualifying companies within three years of the initial issue.

There are also limitations on the level of investment in one company and in the size of each company.

The tax incentives for private investors in new shares comprise income tax relief at 20 per cent on investments up to a total of £100,000 in each tax year. To retain this relief, the investor must hold the shares for at least three years. But, as I mentioned above, my view is that this should be considered a long-term investment, which I would define as seven years or more.

This concession means a £10,000 investment costs the investor a net £8,000, providing a significant buffer against falls in the share price.

When an individual invests in new shares, capital gains tax liabilities of up to 40 per cent can be deferred until the eventual disposal of the shares. For private investors who buy shares in a VCT, there is no liability to income tax on dividends received or to CGT on any gains on the disposal of the VCT shares.

Capital profits within the VCT can be distributed to shareholders as tax-free dividends, which means investors need not sell to realise investment gains. Most VCTs also allow investors to reinvest these distributions of profit into new shares, repeating the tax relief and building the overall investment further.

In practice, most investors have tended to hold on to their shares beyond the minimum time period.

The share prices of most VCTs are quoted daily in the Financial Times to enable you to follow the progress of your investment. However, you should be aware that, in the early years, share prices tend to trade at a lower figure than their net asset value.

This is a summary of the main aspects and tax concessions. The inclusion of VCTs in your portfolio will require me to cover some areas in more detail.

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