The value of the investment capital flow into tax efficient venture capital trusts (VCTs) reached its highest level in a decade over the 2018/19 tax year. Figures from HM Revenue and Customs printed on Tuesday showed inflows of £716 million over the year.
The number of UK investors taking advantage of VCT tax breaks, 30% tax relief as long as shares are newly issued and held onto for at least five years, also increased 24% on the previous year to 18,890 individuals. The growth in the number of VCT investors is ahead of the growth in capital value, which rose just £11 million. That represented growth of just 1.56% compared to the 24% growth rate in the number of VCT investors.
VCTs invest in start-ups, with the vehicle first established in 1995 as a way to stimulate capital flows to small companies that would otherwise struggle to raise investment or qualify for loans from traditional lenders such as banks. The tax breaks offered reduce the risk profile of VCT investments to some extent. However, the exposure to illiquid equity in small companies that a VCT investment represents is still inevitably high risk. Such investments are best suited to higher net worth and sophisticated investors who can afford to take on extra risk in the pursuit of potentially higher returns with at least a portion of their investment capital.
As well as the initial 30% tax credit on the purchase of newly issued VCT shares, investors also benefit from an exception from any capital gains tax that would ordinarily be applied to any returns realised. Dividends paid out by VCTs are also exempt from tax.
2005-06 has been the most successful year on record for VCTs, when 23,610 British tax residents invested £780 million into them. That’s still some way ahead of last year’s totals, both in terms of capital and investor numbers. Upfront tax relief was, however, 40% rather than the current 30%.
But VCTs have seen a resurgence in popularity as a result of a drop in how much can be saved into pension products that offer tax relief. The prospect of higher returns in a recently low-return UK stock market environment has also presumably been a factor. Wealth Club founder Alex Davies commented:
“HMRC’s annual report on VCTs reaffirms their popularity among wealthier and more sophisticated investors. They are one of the last relatively simple and tax efficient investments left for wealthier investors. Performance over the past 10 years has also been good.”
Some financial advisors do, however, warn that the level of risk represented by VCTs means that they are not necessarily suitable for all types of investor. Tom Colburn, a financial planner for Brewin Dolphin cautions:
“While the sector offers a very broad and diverse range of opportunities, they are high-risk investments so should only be considered as part of a multi-asset long-term investment portfolio.”
Investments in VCTs should be made with a long term view and only by investors who are comfortable with tying up some of their capital in an illiquid investment they won’t be able to quickly or easily divest from. They can make a valuable contribution to a portfolio as a higher risk/higher return play as long as investors are fully aware of the risk profile before deciding to invest in a VCT.