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Will VCTs survive the Ucis promotion ban?

Venture capital trusts have thrived since their introduction in 1995, but with the tax efficient investment vehicles facing the threat of falling under the FSA’s ban on promoting unregulated collective investment schemes will their growth grind to a halt?
In August, the FSA published consultation paper CP12-19, which outlined plans to ban the promotion of Ucis to retail investors, with the exception of sophisticated, high-net-worth individuals. Despite VCTs not being specifically mentioned by the rules, they are not given a specific exemption, unlike investment trusts, and the industry is worried that without one VCTs could be hit hard.
VCTs are UK closed-ended collective investment schemes designed to provide private equity capital for small expanding companies and with investors potentially benefitting from income tax relief and exemption from capital gains tax to offset the higher level of risk involved.
The Association of Investment Companies says at the end of October there were 106 VCTs with total assets of £2.5bn. The products saw their best fundraising figures in the middle of the last decade with a record of £779m raised in the 2005/06 tax year.
This boom began in 2004 when then Chancellor Gordon Brown doubled the tax break on VCTs and ended in 2006 when he chose to cut back the income tax relief from 40 to 30 and increased the minimum holding period to qualify for this relief from three to five years.
Following the credit crisis, sales dropped to £158m in the 2008/09 tax year but sales have recovered since then and the past three years have seen sales
of between £300m and £400m. Experts expect similar growth this year before any ban would take effect.
However, the future of the VCT sector remains uncertain until the ban on promoting Ucis is clarified and advisers and asset managers know for certain if VCTs will be affected.
AIC director general Ian Sayers believes the FSA proposal is flawed.
The FSA has outlined several reasons for its proposed ban on promoting Ucis. It says they often use complex or opaque investment strategies, can invest in speculative or high-risk underlying assets, invest in assets that are potentially illiquid, invest in assets that are difficult to value, use structures that are likely to have greater governance risk and or use assets or investment strategies that investors are likely to be unfamiliar with. Sayers says these arguments do not apply to VCTs.
He says: “The FSA proposal to prevent advisers from making recommendations to ordinary retail investors on VCTs is a very big concern for our industry. The FSA have set out six criteria and they believe that any products with these criteria should have their distribution restricted. We believe that these six criteria do not apply to VCTs and VCTs are appropriate products for advisers to recommend to unsophisticated investors. Even if you accepted the FSA’s argument that VCTs do share some of the six criteria, which we do not, there are equally potentially unsuitable products for investors in certain circumstances which are not going to be restricted by these proposals.”
Charles Stanley Direct head of investment research Ben Yearsley says: “If VCTs fall under the Ucis banner, the market will raise £50m a year. Sales will collapse and it will be a disaster. I would be amazed if they were left under the Ucis banner.”
Bestinvest surveyed VCT groups in September on the potential impact of VCTs being in the Ucis ban and found they expected new fund raising would collapse by 75 per cent, choking off the market.
Bestinvest managing director of communications Jason Hollands says: “In our submission to the FSA consultation, we have argued that VCTs have similar characteristics/safeguards to investment trusts, which are to be excluded from the restrictions.
“We have also pointed out that changes to VCT rules implemented this tax year go some way to reducing the risks of these schemes by materially increasing the universe of companies eligible for VCT funding from businesses with less than 50 employees to 250 and from companies with gross assets of less than £7m pre-funding to £15m.”
Hollands believes that although enterprise investment schemes are also likely to be captured by the proposed restrictions, the impact would be much less significant as EIS are already targeted at a more sophisticated and higher net worth audience.
Puma Investments director Eliot Kaye disagrees with Yearsley’s view that VCT sales will collapse ºif they fall under the Ucis banner but warns it will cause unecessary damage.
He says: “We have made a very firm submission to the Treasury on this consultation process that a VCT which is a listed vehicle being caught by this simply seems counterintuitive and a bit odd. We are going to push very very strongly to make sure it’s not caught. I do not think it will kill the VCT market if it did come under the Ucis ban. I think some VCTs will struggle, particularly the retail animals.”
Sayers adds: “Our recommendation is that if you actually want to solve these problems, the answer is not to define this product and say it is restricted, at which point somebody will design a product which looks similar but isn’t covered by the rules.”
Looking towards the autumn statement, Yearsley says it is unlikely that VCTs and EIS will have their tax breaks improved by the Government.
He says: “There’s a lot of negativity in the press about tax breaks, especially when you look at last year when the Government announced they were going to drop the 50 per cent tax high rate band down to 45 per cent. So they are not going to be seen giving away more tax breaks to the “rich”. The chances of EIS and VCT having their tax breaks made even better are virtually non-existent. There’s no political will to do it. VCTs are getting a 30 per cent tax break, which is already generous.”
Hollands says: “Should common sense prevail and the FSA exempt VCTs from Ucis, the market should remain stable, with the potential scope for a slight improvement
in fund-raising as a result of a couple of factors. First, more attractive rules governing the size of a com-pany that can be backed, creating a wider opportunity set and, second,
last year saw some one-off distortion from a couple of launches focused on solar energy being pulled due to the withdrawal of government subsidies.”

VCT Table - Figures from AIC


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