Venture Capital Trusts (VCTs) were introduced in 1995 and are a way of investing in small companies that gives you an immediate tax break of 30% against your income for that year, plus ongoing tax relief against dividends and capital gains. However, they are fairly risky as you are investing in start-up companies with no track record or those listed on the Alternative Investment Market (AIM) that may already have reached their peak. The 30% tax break applies to investments of up to £200,000 per annum. An investment of this amount would knock £60,000 off your tax bill for that year. However, you must hang on to the shares for at least 5 years otherwise you will lose the tax break and have to repay any tax deducted.
VCTs are quoted companies that invest their shareholder's funds in smaller unquoted trading companies. Most are run by investment managers and raise their funds from private investors. There are 4 different types of VCT as follows:
- Generalist funds that invest in a variety of sectors
- Specialist funds that invest in specific sectors
- AIM-based funds that invest solely in the AIM
- Limited life funds that last a certain number of years
The VCT has to satisfy certain conditions in order to qualify for tax relief. Probably the most important of these is that a VCT cannot invest in a company that employs more than 50 people or whose gross assets immediately before the investment exceed £7 million. The VCT must also invest at least 70% of its funds in unquoted companies carrying on a qualifying trade wholly or mainly in the UK and which meet the scheme conditions and it cannot invest more than £1 million a year or more than 15% of its total funds in a single company. If any qualifying conditions are not met at the relevant times, the Revenue has the power to withdraw approval and claw back tax relief previously given to investors.
It should be noted that tax relief on VCTs is only granted to the original subscriber, not to any subsequent purchaser. This may affect the price you get when you come to tell your VCT shares. However, the income tax and capital gains tax exemptions would continue to apply subject to the £200,000 limit.
As capital gains on a VCT are exempt, any losses you make on your VCT shares cannot be offset against other capital gains on your tax return.
Also, you cannot claim more tax relief on a VCT than you owed in tax for that year, so if your tax liability for the current year looks like being less than 30% of your planned investment you should postpone some of it until next year.
VCTs are a great way to reduce your tax bill or get a big refund from the Revenue, but you should never allow the tax advantages to take precedence over normal investment considerations. They are extremely risky and you must be sure that you can afford to take a loss on them or even lose your money completely. You must also make sure you can afford to do without the money for at least 5 years as you may have to repay all the tax you saved if you sell the shares early. In addition to all this, VCT management charges may be quite high and less transparent than other investments. However, perhaps the biggest risk is that there is only a limited secondary market for VCT shares and you may find them hard to sell. Some VCT managers do offer a Buy Back facility but these are normally at a discount to net asset value so you would not get as much money back as you expect. Therefore, VCTs are only for long-term investment by individuals who are prepared to accept a fairly high level of risk.