The Venture Capital Trust (VCT) scheme and opportunities for income tax relief

VCTs attracted record amounts in the last tax year, with ￡1.13bn raised by investors to be invested into small and innovative UK firms, according to data from the Association of Investment Companies (AIC).

As VCTs back smaller, earlier-stage companies, there is risk associated with a VCT investment - but there are also opportunities for investors to grow their money while taking advantage of a number of tax benefits.?

Below we explain how VCTs work, how they could help your clients and the developments that could shape the scheme over the coming years.

This Q&A is a summary of our recent webinar on VCTs and the opportunities that they can provide for tax relief. The discussion was led by specialist tax adviser Philip Hare, who is a Partner at Philip Hare & Associates, alongside Anne O'Loughlin, Sales Manager at Beringea, the investment manager of the ProVen VCTs. If you would like to be invited to our webinars in the future, then get in touch at [email protected].

What is a VCT?

A Venture Capital Trust (VCT) is a company, listed on the stock exchange, that pools together money raised from private individuals. This money is then used to invest in smaller companies in the UK which qualify for VCT investment.?

VCTs were launched in 1995 and since then have become increasingly popular. There are a number of reasons for this. One is of course the 30% upfront tax relief incentive, along with VCTs’ strong track record over the years and the fact that pension tax reliefs have since been curtailed, meaning people are looking at VCTs as a supplement to pension planning.

VCTs also provide an important long-term source of finance for growing companies throughout the UK. These entrepreneurial businesses have the potential to have an outsized impact on the country’s productivity, economic growth, technological innovation, and job creation.?

Key features for investors in VCTs:

• 30% income tax relief available to investors
• Maximum investment of ￡200,000 per year to claim the tax relief
• Minimum five-year holding period
• The relief is restricted if shares in the same VCT are sold within six months
• You can buy VCT shares on the open market, or you might be given them or inherit them - but the annual ￡200,000 limit still applies

Other tax considerations related to VCTs:

As well as the income tax relief, there are other considerations when using VCTs for tax planning, including tax incentives that attract investors and differences from our tax-advantages investment products such as EIS and BR:

• VCTs regularly pay dividends to shareholders, particularly when they have sold an investment and returned cash into the funds. These dividends are tax free and you don’t have to put them on your tax return. So they are not taxable.
• There is no capital gains tax (CGT) on VCT shares, and there is no minimum holding period to qualify. So if you make a gain on them, then there's no tax to pay on it. But equally there are no loss reliefs.
• If you hold VCT shares that were bought before 2004, there was an additional capital gains deferral relief, meaning you could roll over a capital gain that you had made into a VCT shareholding and gain wouldn't become chargeable for tax while holding your VCT shares.
• VCTs do not qualify for inheritance tax (IHT) relief. Because VCT shares are listed on the main stock exchange, they do not attract business property relief even though the underlying investments are in companies that otherwise would qualify.

How do investors claim the income tax relief?

Below are the key steps for claiming tax relief:

• The VCT provides a shareholder certificate to the investor
• The relief is claimed at step six of the income tax calculation on a tax return
• Can therefore be used against tax on earnings, pension, interest, dividends and rental income, reducing an individual’s overall tax bill
• Doesn’t reduce relief or income that come after step six of the tax calculator - such as non domicile charges or clawback of child benefit relief

What types of companies qualify for investments from VCTs?

1. It must be a small company

VCTs are aimed at fairly small companies and there are limits on the amount that companies can receive through VCT investments.?These are ￡5m per annum and ￡12m in a lifetime.?For companies doing a lot of R&D work, these limits are enhanced and potentially there is a lifetime limit of ￡20m that companies can receive from tax advantaged sources.

2. The funds must be used for growth?

The VCT money must be used to grow and develop these companies.?So companies need to have a growth plan and to demonstrate that they are using that money in order to grow the business - not just to keep it in a steady state.

3. The company must be relatively new

There is also an age limit that has to be met. Generally, the company has to be less than seven years’ old at the time the VCT makes its first investment. This is to make sure that funding is targeted to the younger earlier stage companies that might find it more difficult to raise money because they don't have a track record.?

The company can have received other investments in the past - such as EIS - as long as the VCT funding is used for the same activities as were funded by the original investment.

4. There must be an element of risk

The investment must be a risk. A number of these companies will ultimately fail because of the nature of what they're doing and the technologies they may be developing. The tax relief is given because investors are bearing some risks. The risk is mitigated by the tax relief and because the VCT invests in a portfolio of companies. As an investor, you hope for organic growth and hopefully a nice profit that can be realised on an exit at some kind.

To summarise, for a company to receive VCT investment they must:

• Be under seven years old
• Have a UK presence
• Employ fewer than 250 employees
• Have less than ￡15m worth of assets on the balance sheet

How does the VCT tax relief interact with pension contributions?

When you put money in a pension, it reduces your taxable income. This happens before you apply the VCT tax relief in the income tax return. So this might restrict the amount you can invest in VCTs if your income tax is reduced due to payments into your pension.?

What happens to the VCT on the death of an investor?

The shares passed into the estate of the deceased. There is no clawback of tax relief on the death of the investor. The executives then appoint the assets of the estate as expressed in the will.

What is the process of selling a VCT?

Providers may operate a share buyback policy that may be at a discount to the net asset value (NAV) of the VCT at the time.?

What does the future hold for VCTs?

The recent two or three years have proved the need for VCTs perhaps more than ever before. When COVID-19 rocked the economy, VCTs were able to back companies in their portfolio that needed particular help at that time.?

This is because they had money already raised and under management that they could deploy to those companies quickly, while also providing expertise.

There's also been a lot of startup companies that have emerged since the pandemic, as well as those developing technology to meet higher requirements for remote working. A lot of VCTs have backed these sorts of companies.?

Now of course we've got other pressures in the economy, with the Ukraine war and the cost of living crisis, and VCTs have access to pools of cash that they can roll out quickly. VCTs are investing across the UK, and can play an important role in the next chapter of economic growth across the country.

What impact will the sunset clause have on VCTs?

When legislation relating to VCTs was last reviewed in 2015, the EU required the UK to put in place legislation that the income tax relief is only available for a 10 year period. So tax relief is only available at the moment for shares which are issued before 6 April 2025. This is known as the ‘sunset clause’.??

On Friday the 23rd of September, the extension of the Sunset Clause beyond 2025 was announced. The new expiry date is yet to be confirmed. Should the Sunset Clause not be renewed in the future, this may make it difficult for the Companies to raise additional capital.

However, the other tax reliefs relating to VCTs - including dividend relief and capital gains tax disposal relief will continue because the sunset clause does not apply to those. Nonetheless, the sunset clause could affect VCTs and the ability to fundraise if there is no income tax relief - the main benefit to investors.

The industry is actively engaging the Government to discuss the vital impact of VCTs on the UK economy and the importance of safeguarding the future of the scheme - as well as EIS and SEIS, which are also impacted by this legislation. These conversations have been positive and constructive, so we are hopeful about the future of VCT investing in the UK.

*As with all investments, your capital is at risk and past performance is not a reliable indicator of future results.

UK tax rules and regulations are subject to change, and such changes may be retrospective. Your ability to obtain tax reliefs will depend on your personal circumstances.

About us

Beringea is a transatlantic venture capital firm that manages the ProVen VCT and ProVen Growth and Income VCT. The ProVen VCTs typically target firms turning over more than ￡1m and invest between ￡1m-￡10m. Beringea aims to launch a new fundraising round for the ProVen VCTs later this year. For more information, please email [email protected].