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The pros and cons of investing in VCTs

6 Oct 2017

This article first appeared in Professional Paraplanner.

Tax year-end will always be the busiest time of year for the advice profession, for several reasons. The early months of the year are traditionally when people think about money and are in the mood to get things done. And, no matter how early you approach clients about getting their finances in order before 5 April, there will still be some who leave it as late as possible.

But as with many things in modern life, the seasons have started to converge. Today people don’t necessarily want to risk leaving it to the first flush of spring to start tax planning. Moreover, in recent years, the Government has announced significant changes to pension regulations, and also the rules relating to tax-efficient investments. As a result, many high earners, particularly those who are getting closer to retirement age, are now feeling far more constricted as to how much they can put into their pension. For many clients, waiting almost a full year to do something about their situation may not be desirable. More investors are therefore starting to think about tax-efficient investing throughout the year.

Which brings us neatly on to Venture Capital Trusts (VCTs). VCTs arrived in 1995, as a way to encourage greater investment in small but growing UK businesses. The main aim of the legislation was to drive economic growth and job creation. VCTs support newer, entrepreneurial types of companies, which have traditionally been under-served by more conventional methods of company funding.

The tax benefits of a VCT can be quite attractive. Investors are able to claim up to 30% upfront income tax relief on the amount invested, provided they are willing to keep holding the VCT shares for at least five years. Another valuable benefit is that VCTs are able to pay tax-free dividends, although dividend payments are not guaranteed. Finally, should the investor decide to sell their VCT shares, and they are fortunate enough to make a profit, the proceeds won’t be liable for capital gains tax. Of course, it’s always worth remembering VCT tax benefits are there, in part, to offset the higher risk associated with investing in smaller companies. And, as with any investment, investors may not get back the full amount invested. An investor’s tax treatment will also depend on their individual circumstances and tax incentives may change in the future. The tax reliefs also depend on the VCT maintaining its qualifying status.

For many investors, there’s a ‘feel-good factor’ associated with investing in VCTs, arising from the opportunity to share in the growth potential of fast-growing, exciting and entrepreneurial young businesses. Not all smaller companies go on to be successful, but there are some great examples of companies that started small but flourished with the benefit of VCT investment, and ultimately have gone on to even greater success, while delivering significant returns for investors along the way.

When it comes to recommending VCTs, there are several factors worth considering to help narrow the search. For example, how long has the VCT been in existence? How experienced is the VCT manager? A well-established VCT should be able to demonstrate a performance track record, whereas newer VCTs can take longer to reach the size and scale required to start delivering meaningful returns for investors. It therefore may be worth looking at more mature VCTs featuring diverse portfolios of companies that are already hitting their stride.

VCT shares tend to have a very limited secondary market, as second-hand shares no longer qualify for income tax relief. Therefore it’s important that investors are able to find buyers for their shares when it comes time to sell them. Most VCTs will offer a share buyback facility, where the VCT itself offers to buy the shares back from the investor at a discount to net asset value (NAV). However, it’s well worth determining the size of the discount, and any other caveats regarding the timing of share buybacks, as these will vary by manager.

It’s also worth noting that investors can now buy VCTs shares for the first time through their ISA. This should give even more people access to the planning benefits of a VCT, the growth potential of smaller companies and valuable tax benefits, all within the UK’s most popular tax wrapper.

While changes to legislation means the range of companies that now qualify for VCT tax reliefs is smaller, we believe there will continue to be a good pipeline of potential investment opportunities, and we recently launched new share offers for two of our VCTs. There’s still a thriving and fertile market full of the type of fast-growing smaller companies, many of whom would be delighted to secure access to funding, that VCT managers look out for. From a supply and demand perspective, the reduced number of VCTs open for investment coupled with the fact that demand for VCTs is likely to far outstrip supply, means that both advisers and investors should be warned that their favourite VCTs could fill up fast. In years gone by, tax-efficient investment was something to think about mostly in the few months before tax year-end. This is no longer true. There’s a strong case to invest in VCTs at any time of the year, while stocks last.

For journalists in their professional capacity only. The value of an investment, and any income from it, can fall as well as rise. Investors may not get back the full amount they invest. Tax treatment depends on individual circumstances and may change in the future. Tax reliefs depend on the VCT maintaining its VCT-qualifying status. VCT shares could fall or rise in value more than other shares listed on the main market of the London Stock Exchange. They may also be harder to sell. Past performance is not a reliable indicator of future results. Personal opinions may change and should not be seen as advice or a recommendation. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880.