Will the Chancellor squeeze VCTs?

    4 November 2017

    Wealthy investors have a particular reason to keep an anxious eye open for Philip Hammond’s autumn Budget on 22 November. With pension contribution tax relief sharply scaled back in recent years, and interest rates still ultra-low (even if we’ve seen a quarter–point rise this week), there are concerns that the Chancellor may be pushed into taking steps to tighten up the rules on other favoured forms of tax-efficient saving for the better-off.

    Included in that list are Venture Capital Trusts, one of three innovations — the others being the Enterprise Investment Scheme and the launch of the Alternative Investment Market — introduced in the 1990s to encourage individuals to invest in startup and early-stage businesses. All three offer investors potentially handsome tax advantages in return for the risk that the businesses they back will struggle or fail, as many invariably do.

    VCT tax benefits include 30 per cent income tax relief on your initial investment up to a maximum investment of £200,000 a year, dividends free from income tax, and exemption from capital gains tax on disposal. These benefits are all dependent on investors leaving their money in the VCT for a minimum of five years: the tax savings can be reclaimed by the taxman if the investment is held for a shorter time.

    Financial advisers rate VCTs as among the best options for higher-rate taxpayers who have already maxed out on their entitlement to pension contribution tax relief plus their annual £20,000 ISA allowance. VCT’s ability to pay tax-free dividends makes them particularly attractive, not least because they are permitted, exceptionally, to distribute not just income but also their capital gains in the form of dividends.

    A VCT that issues shares at 100p and pays an annual dividend of 5p, which is a level that many established VCTs target, will effectively yield over 7 per cent per annum after taking account of the 30 per cent upfront tax relief. In practice, most VCTs are happy to see their share prices settle below their issue price in order to maximise the tax-free dividend returns.

    The thinking behind the VCT initiative was that government gains more from spawning a new generation of startup and early-stage companies than it foregoes in tax receipts from the investors concerned. That has certainly been the case so far. VCTs have spawned a number of successful companies which now pay plenty of tax on their profits and employ thousands of tax-paying employees. Probably the most famous example of a VCT-backed success story is the property website Zoopla.

    Why then is there concern that the Chancellor may have set his sights on scaling back the favourable VCT regime? One explanation is the Treasury’s evident (and hardly unprecedented) need for additional savings. Whenever Treasury budget-drafters look around for easy wins, eliminating tax reliefs always figures large.

    The second is the announcement earlier this year of the Patient Capital Review, a Treasury-led initiative to investigate ways to fill the so-called ‘equity funding gap’ that is widely believed to have prevented many startup businesses from growing into the world-beaters that other countries seem to be so much better at nurturing. Why, the argument goes, do so many of our best technology companies fail to grow into our very own Googles and Amazons and so often end up being taken over by smart foreign-owned businesses? Maybe government support for growing businesses should be spent in other directions.

    Jo Oliver, who manages Octopus Titan, the largest VCT — which grew out of an earlier ‘angel investor’ network and has backed Zoopla among many other successes — argues that VCTs are not part of the problem. The gap that needs to be plugged, in his view, relates to later-stage companies that have the potential to go global but are not yet big enough to attract conventional backing from big banks, credit markets and institutional investors.

    A more plausible reason to tinker with the VCT regime is that the portfolios of a number of established VCTs have matured so far that they are no longer in practice the pure risk-capital vehicles the tax concessions were designed to encourage. Two years ago, the rules governing what VCTs are allowed to hold in order to retain their tax-privileged status were tightened up for this very reason. They now have to invest in a higher proportion of higher-risk early startups, for example. These restrictions might be tightened again.

    Where does all this leave this year’s crop of VCT offerings? It is indicative of the nervousness around the sector that many providers of VCTs are looking to raise more money than they would usually do, just in case the Chancellor hits them with an adverse rule change — better therefore, from their perspective, to bank enough now to keep them going for the next couple of years.

    For would-be VCT investors the equation is less simple. Would the Chancellor dare to make any clampdown on reliefs retrospective? Probably not, but new rules could be imposed from the date of the Budget rather than the next financial year. Without knowing what form any changes might take, it’s impossible to say how far they might alter the risk-reward balance of VCTs. At the time of writing the signs are that many investors are buying the ‘Hurry while stocks last’ message — which rarely fails in the investment business. According to the Tax Efficient Review, as at 30 October a total of £261 million had been committed as subscriptions to VCTs this financial year, against a total fundraising target of £672 million announced so far.

    Alex Davies, founder of The Wealth Club, a broking firm that deals exclusively in tax-favoured investments, says he would not be surprised if the total raised by VCTs this year exceeds £800 million. That will make it comfortably the sector’s best fundraising year to date, beating the £527 million raised in 2016-17, and potentially costing the Treasury £240 million in foregone income tax. Whether he does anything or not, Philip Hammond is already on course to become the VCT salesman of the year.

    Which VCTs to invest in?

    Venture Capital Trusts come in many shapes and sizes — some small and very specialised, others bigger and more generalist. As VCTs are high-risk investments, the most prudent strategy is to spread your money across a number of the more established generalist and AIM VCTs. Some providers manage a range of VCTs, often later consolidating them. Current offers include:


    Provider: Baronmead

    Target to raise £m Up to 60
    Raised so far 33
    No of VCTs 2



    Target to raise £m Up to 80
    Raised so far 35
    No of VCTs 3



    Target to raise £m 60
    Raised so far 44
    No of VCTs 3



    Target to raise £m 30
    Raised so far 5
    No of VCTs 2


    Octopus Titan

    Target to raise £m Up to 200
    Raised so far 29
    No of VCTs 1


    Unicorn AIM

    Target to raise £m Up to 50
    Raised so far 26
    No of VCTs 1

    Source: Tax Efficient Review, The Wealth Club


    Examples of historic returns

    Past performance is no guide to the future, but these are among the best performers. The first three are generalist VCTs. Octopus Titan has the best track record of finding innovative new businesses. Unicorn runs the best-performing of several VCTs that specialise in AIM shares (others include Octopus, Amati and Hargreave Hale). Specialised VCTs are best avoided without professional advice. Note that VCTs can be sold after investment, but the market is not very liquid, the spread between buying and selling prices can be wide, and many trade at a discount, although most trusts offer to buy back shares periodically at a 5-10 per cent discount to Net Asset Value. Running costs are higher than with ordinary funds, with an average on-going charge ratio of 3.4 per cent per annum for generalist trusts and 2.3 per cent for AIM funds.


    VCT: Baronmead

    Total return over 5 years % 68
    Net assets £m 185
    Discount to nav % 4.7
    Share price [pence] 89


    Mobeus Income & Growth

    Total return over 5 years % 93
    Net assets £m 58
    Discount to nav % 9.1
    Share price [pence] 66


    Northern 2

    Total return over 5 years % 85
    Net assets £m 74
    Discount to nav % 15.4
    Share price [pence] 93


    Octopus Titan

    Total return over 5 years % 110
    Net assets £m 418
    Discount to nav % 4.6
    Share price [pence] 89


    Unicorn AIM

    Total return over 5 years % 113
    Net assets £m 181
    Discount to nav % 13.4
    Share price [pence] 141

    Source: Association of Investment Companies, as at 15 October