By Kimberley Malin DipPFS Cert CII (MP)
Investing in small, unlisted and higher-risk companies makes a VCT a similar concept to an EIS or SEIS. A VCT, mechanically, is similar to an Investment Trust whereby both a VCT and Investment Trust are limited companies which are run by fund managers.
We see VCTs used as a tool within financial planning often; however, being able to identify when and how to recommend these is not as simple as with an ISA or GIA.
When you invest in a VCT, you become a shareholder in a trust, not of the individual companies which the trust invests in.
Investors can buy new share offerings through a newly listed VCT, or they can buy shares on the secondary market. If shares are purchased on the secondary market, investors do not get the 30% tax relief; however, you can still benefit from tax-free growth and tax-free dividends. If purchased on the secondary market, there is also no minimum holding period.
There are three different types of VCTs:
- Generalist VCT – these types of VCTs invest across a diverse range of companies across a range of sectors. They do this to spread the risk across different sectors – when one sector is taking a downturn, the other may be experiencing growth. This helps to manage the risks and losses and/or growth in the portfolio.
- AIM VCT – the AIM market was created as an alternative market to the main London Stock Exchange for those companies that could not meet the demanding and expensive requirements set out by the London Stock Exchange. Not all companies that are listed on AIM are small and inexperienced companies but many of them will be. The AIM VCT invests in these companies listed on the AIM stock market.
- Specialist VCT – this is a VCT that focuses on a particular market. As you can imagine, with the lack of diversification, this is the riskiest type of VCT.
A VCT must be held for a minimum of five years to achieve the tax benefits.
These are the main tax incentives of a VCT:
- Income tax relief is given to investors for qualifying investments at a rate of 30%. Relief is available up to a max of £200,000 investment (per tax year) – this will provide a maximum tax-relief incentive of £60,000. Note that the tax relief is given as a tax-reducer, so you must have a tax bill equal to the relief you are trying to claim.
- Dividends received from the VCT investment are tax free.
- Any tax relief claimed can be withdrawn again if the investment is not held for five years.
- With a VCT, you can get immediate CGT exemptions on any growth, and, as a result, no losses are allowable and/or claimable.
- Unlike an EIS, Capital Gains Tax deferral relief is not given on a VCT.
- VCTs do not benefit from Inheritance Tax relief like an EIS does.
VCTs are risky
VCTs are usually very high risk, and investors should not invest money they cannot afford to lose. Tax rules can change in the future, and the above tax incentives may not always be available. They are not for every client and not for inexperienced or nervous investors.
What does a client look like where VCT could be considered?
- Clients should have a sophisticated grasp on businesses and investments.
- The client should be able to take the highest level of investment risk and expect that there will be losses in the portfolio. Although you can segment a need, and the rest of the client’s portfolio can remain lower risk, the client needs to understand that this type of investment is very high risk, possibly, compared to what they are used to investing in, particularly if they are a first-time EIS / VCT investor.
- The client should have a longer-term investment horizon. As a minimum, the investment needs to be held for five years to benefit from tax incentives. Not only that, but some investors will also wait a number of years to see successful investment ‘pay off’.
So where can a VCT fit into a client’s Financial Plan?
The big obvious reason to invest in a VCT is the tax planning opportunities available, due to the incentives on offer; however, where else does this specialist product fit in?
VCTs can add diversification to a client’s portfolio, if they are willing to accept the risk associated with the investment, and can be useful for clients with particularly large investable assets. Smaller companies typically follow different investment cycles compared to other parts of the investment market, so this is what creates the extra layer of diversification. A VCT can be used to complement the other products the client has (however, should not be seen as a replacement for other mainstream investments, such as ISAs and pensions, but an addition).
As a VCT pays tax-free dividends, this can prove an attractive option for supplementary income and could be especially attractive to those approaching retirement.
Furthermore, by investing in these smaller companies, the investor is contributing to the future of the economy and country through their new, exciting and innovative ideas. People love to see others do well; they like to see success, and being part of that journey can bring huge satisfaction.
Clients have their standard stock market investments, and, as they aligned to their agreed level of investment risk, they roughly know what to expect, but with a VCT, clients have an element of excitement around this as the potential for growth can be huge.
In summary, of course, VCTs have their place in some client’s Financial Plans, but this type of product requires careful consideration of both the risks and benefits associated with it before a recommendation is made.
VCTs are complex specialised products that should be carefully considered before proceeding with an investment. Information quoted is based on the tax rules in place at the time of writing (Feb 2024), and this article should not be considered as advice.
If you need any support in understanding or recommending VCTs, please drop us a line, as we often get involved in researching suitable VCTs for clients and putting together recommendations.
