Venture capital trusts (VCTs) are becoming the talk of the investment town.
According to HM Revenue and Customs (HMRC), VCTs issued shares to the value of £1.1bn ($1.33bn, €1.25bn) in the last tax year, a 68% increase when compared to £668m in 2020/21.
Some 19,475 UK investors claimed tax relief on £640m of VCT investment in the 2020-21 tax year, a 9% increase from a year earlier.
But should more advisers look at VCTs to lower their clients’ tax bills?
John Westwood, group chairman of Blacktower Financial Management, said: “As with higher risk investment vehicles, if managed correctly VCTs can be incredibly lucrative, offering potentially significant returns with generous tax relief.
“However, it is important that a client is made aware of the risks that accompany VCTs before any decision is made, as whilst it is true they can be effective in reducing tax liability, there is also a very real possibility of sustaining substantial losses, especially as VCTs are notoriously difficult to sell on due to them losing their tax advantages after second-hand purchase.”
Richard Manley, chief executive of Seneca Partners, said: “The reduction in tax reliefs available in other areas such as pension contributions makes tax efficient investments such as enterprise investment schemes and VCTs even more appealing – particularly for those clients seeking to reduce their tax bills. VCTs in particular can offer instant access to a ready-made diversified portfolio of investments in UK SMEs with big ambitions and attractive profit potential – in addition to the 30% initial tax relief and tax free dividends.”
Dean Kemble, chief commercial officer at GSB, added: “For some high income individuals who are restricted in their ability to make pension contributions, they may find that such investments are the only realistic options to mitigate some of their income tax.”
Toby Band, managing director at First Sentinel Wealth, added: “Advisers should be considering VCTs for high-earning individuals with higher attitudes to risk. Annual allowance severely limits tax-efficient pension contributions for high-earning individuals, in some cases to just £4,000 per year.”
Trust
The VCT market is used by advisers but not all – so this suggests that there is a still a trust issue with using them for clients.
So, can advisers trust VCTs?
Jack Rose, head of retail sales at Triple Point, said: “Clearly, they are not without their risks, given the investment universe. However, as an investment vehicle, VCTs have been around for close to 30 years. The market has matured considerably over that time. There are now a core group of c.20 established and experienced managers who have an established track record in the VCT market and have meaningful track records to point to.
“Clearly past performance is no guide to future success, but it should give people a degree of comfort to review how each fund has performed in different market cycles.”
Alan Sheehan, director at Micap, said: “There is no question that VCTs are high risk investments, and so they will not be suitable for all client types. However, VCTs are listed on the stock market, which means that they have significant governance requirements to adhere to. They have also been around for almost 30 years, and so there is a good amount of performance data to consider. Doing the right research is key.”
Madeleine Ingram, director at Calculus Capital, added: “Most advisers see VCTs as the next sensible step in tax management after an investor has used their annual ISA and pension allowance. Over the last 25 years, VCTs have established themselves as a reliable and consistent source of tax relief for a range of investors.
Pros and cons
Advisers have to weigh up whether they feel comfortable using VCTs for their clients. There are an array of positives and negatives to discuss about advisers using VCTs.
Luke Barnett, head of tax advantaged strategies at St James’s Place, said: “The underlying investment opportunities are also attractive – the ability to support growing UK businesses, and to encourage growth in new and exciting technologies adds to the appeal. These early-stage companies tend to invest in new ideas and technologies, with a heavy element of research and development. Further to this, the VCT market continues to mature, and these vehicles are starting to operate at significant scale, with large balance sheets with which to support portfolio companies.
“Not only does this help to promote employment, but it also helps to position the UK economy for long term growth. Coupled with the benefits of tax-free dividends, along with generous upfront tax reliefs, it is easy to see the appeal for investors.
“However, while there are favourable tax benefits from VCTs, it’s important that advisers work with clients to help diversify the risk associated with investing in early-stage companies and select the right VCT strategy for their clients. Many start-ups do unfortunately fail and therefore VCTs should be considered as part of a broad investment portfolio.”
Keith Lassman, head of capital markets at Howard Kennedy, added: “The growth in the market obviously adds to financial advisers’ array of well managed recommended financial products for retail clients in which they can charge out and receive generous adviser fees. As the market continues to grow there will be increased interest from financial advisers recommending these products.
“VCTs clearly have attractive tax reliefs and advisers should certainly be considering these vehicles for their clients as a means of wealth management and tax planning. VCTs are not only for those individuals with excess cash who have maxed out their annual and lifetime pension allowances looking to reduce their tax liabilities, but are also for younger investors who are looking for tax free investment income in the form of regular dividends as well as potential capital growth.”
Jason Coppard, financial planning manager at Lumin Wealth, added: “VCTs can be an opportunity to diversify an investment strategy at the same time as benefitting from valuable tax advantages. It is also essential to note that VCTs are much higher risk in nature than other investments, and must be held for at least five years (to retain the tax benefits), so should be considered illiquid during this period.
“Nevertheless, for a client who would benefit from these two key tenets, and who might also be impacted by the tapering of their annual allowance, or wish to build an alternative tax-free income stream, for example, it can be a valuable option to consider.
“Regardless of the benefits it is always important to choose the right financial planning partner with strong due diligence, as not all VCTs are created equal, and not all client outcomes are positive.”
