The venture capital trust industry has recovered since the rule changes in last year’s Budget and VCTs continue to offer investors great tax-saving benefits and some exciting investment opportunities in UK plc.
On inception in 1995, investors were attracted to VCTs by the combination of 20 per cent income tax relief and the ability to defer capital gains tax. In 2004, although the latter was dropped, the up-front income tax relief increased to 40 per cent against any income tax payable in the relevant year.
This led to a boom in VCT subscriptions but one which was relatively short-lived when, two years later, on April 6, 2006, the rate was dropped to 30 per cent.
In addition, shareholders need to hold their shares for five years to retain this quantum of tax reclaim for good. Today, for every £10,000 subscribed into new VCT shares, the shareholder is therefore able to reclaim £3,000 against their annual income tax liability compared with £4,000 less than 12 months ago.
But although some of the tax benefits have changed, the underlying structure of VCTs has not. They are still required by legislation to focus on a portfolio of small to medium-sized enterprises with a capacity to grow their businesses. The increase in the underlying values of each investment, of which there are typically 30 or more in a trust, allows private investors to enjoy potential growth in their original subscription.
Not unlike Isas, VCTs also offer shareholders tax-free dividends, provided they are UK taxpayers, over 18 years old and on the condition that they have not invested more than £200,000 in any one financial year. This Isastyle tax relief rarely gets a mention, yet over the last 11 years, the benefit of tax-free dividends, especially for higher-rate taxpayers, has been substantial and often higher than the up-front income tax relief, particularly for those invested in some of the better-performing VCTs.
IFAs remain the dominant investment channel for high-net-worth investors, with more than 90 per cent of subscribers in the five Baronsmead VCTs referred by IFAs. In their research of VCTs, IFAs tend to focus on the investment merits and skills of each VCT manager employed by the board of directors but they can rest safe in the knowledge that each VCT is a fully listed public company which has had to pass stiff FSA examination to raise capital.
The public company status offers good corporate governance and requires VCT managers to provide regular and transparent communication as well as an articulation of the key risks associated with VCTs.
Investors have 11 years of performance history for VCTs investing in unquoted as well as those investing in Aim-traded companies.
The last two years have seen the launch of limited life VCTs, where the directors have the stated intention of returning capital over three to seven years but their ability to do this remains unproven. Neither do they fit the Government’s policy of recycling the initial capital as investments are made and then sold and, in so doing, achieving successive rounds of higher economic growth for many of the portfolio companies.
In respect of generalist and Aim VCTs, there have been some positive performance trends over the last five years as many VCT managers learned which investment style allows them to get the best out of their diversified portfolios. Private equity disciplines are the dominant style, representing about 50 per cent of the market. Key to this is active management both in terms of seeking out the right investment opportunities as well as becoming influential non-executive directors on investee company boards.
There is also a wide selection of VCTs which specialise in a particular sector or activity, where the diversification is reduced but where investors have the potential for being rewarded with higher returns in exchange for the risks taken.
Often, Aim-traded investee companies have similar characteristics to unquoted companies. Aim gives them exposure to public markets plus the continuing corporate governance obligations that go hand in hand with a public listing.
It is difficult for private investors to access a selected portfolio of such investees in any other way and also to be so tax-efficient.
It is unlikely that the headline tax regime will change for the life of this Parliament (probably another three years), allowing advisers to plan both for this year and beyond and spread their clients’ tax-efficient VCT investing across the economic cycle.