The 2017-18 tax year has seen another strong performance for venture capital trust (VCT) fundraising. The latest figures suggest VCTs raised more than £670 million, well ahead of the £542 million raised in 2016-17.
- The appeal of VCTs has grown beyond the tax-efficient investment niche
- Investors are adapting to changes in government policy over the last few years, in particular new rules around pensions and buy-to-let
- The sooner you have a good idea what clients want to do with VCTs, the better position you’ll be in when fundraises start opening again
Investor demand saw several VCTs hit their fundraising capacity ahead of tax year-end. One of these, Octopus Titan VCT, raised £200 million, the largest ever VCT fundraise.
The appeal of VCTs has grown beyond the tax-efficient investment niche, with national newspapers increasingly covering them in their personal finance pages.
One reason VCTs are growing in popularity is that investors are adapting to changes in government policy over the last few years, in particular new rules around pensions and buy-to-let.
Pension restrictions have become tighter
Let’s start with pensions. Recent years have seen increasing restrictions on annual and lifetime pension contributions.
Much of the money held in pensions sits in bonds and tracker funds. The Treasury has recognised that the most dynamic businesses are not those large companies whose shares are held by tracker funds, and which raise money from the corporate bond market.
No, they’re small, often privately-held businesses that have the potential to grow much bigger. These are the companies that, more than others, drive economic growth.
The Octopus High Growth Small Business Report, published last month, finds that less than 1% of UK businesses account for more than 20% of growth. These small companies create one-in-five new jobs – more than 3,000 jobs a week.
The key to stimulating economic growth is encouraging investment into these high growth small businesses so they can scale up rapidly. This is precisely what VCTs exist to do. So, quite reasonably, the Treasury would rather give tax incentives through VCTs than through pensions, because VCTs direct capital to where it does the most good.
How VCTs can complement retirement planning
Of course, this does mean more clients are now looking for ways to complement their retirement planning. VCTs can help them do this.
For example, a client who’s worried about exceeding their lifetime allowance (LTA) could instead invest some money into a VCT, giving them exposure to a portfolio of early stage businesses with high growth potential. This means they need to be comfortable with the risks of investing in smaller companies, and the fact that they could get back less than they invest.
As an incentive to take on these risks, VCTs offer upfront income tax relief equal to 30% of the amount invested (this applies to the first £200,000 invested). They also offer tax-free dividends and capital gains. This makes them a tax-efficient way to invest for retirement, and one that doesn’t use up a client’s LTA.
Clients can also use VCTs to take money out of their pension tax efficiently. By investing some of the money they take out into a VCT, clients can use the upfront income tax relief to offset the tax they pay on the money they withdraw. Note that a client should be comfortable investing in a VCT for at least five years. If they sell their VCT shares earlier than that, they would need to pay back any income tax relief they claimed.
VCTs can also help landlords offset rising costs
Buy-to-let is another area where the government has tightened restrictions in recent years.
Again, the goal is to channel investment away from activities that do little to stimulate growth and towards those that help build the next generation of British businesses. There’s also a concern that buy-to-let has made it harder for first-time buyers to get onto the first rung of the property ladder.
The recent changes in legislation, such as the phasing out of buy-to-let mortgage tax relief, mean more landlords are looking at the tax implications of rental income. The costs of being a landlord are rising, and claiming income tax relief on a VCT investment can be a way to offset them for clients who don’t want to sell their properties.
VCTs are also an accessible investment for many younger people who, in previous generations, may have considered property investing. Today, a buy-to-let mortgage will often require a six-figure deposit.
By contrast, the minimum investment for VCTs starts at a few thousand pounds, and comes with upfront income tax relief. It’s important to make clients aware that tax treatment depends on individual circumstances, and may change in the future. Tax reliefs also depend on the VCT maintaining its VCT-qualifying status.
Why you should start talking to clients about VCTs now
As we head into the new tax year, it makes sense to start talking to clients about VCTs sooner rather than later. The sooner you have a good idea what clients want to do with VCTs, the better position you’ll be in when fundraises start opening again.
For one thing, you’ll be more likely to help your clients take advantage of early bird discounts. The 2017-18 fundraise for Octopus Titan VCT saw nearly 3,000 investors claim an early bird discount. It also means clients can claim their 30% income tax relief sooner.
Paul Latham is a Managing Director at Octopus Investments, the largest provider of VCTs in the UK.
The value of an investment, and any income from it, can fall as well as rise. Investors may not get back the full amount they invest. Tax treatment depends on individual circumstances and may change in the future. Tax reliefs depend on the portfolio companies maintaining their qualifying status. The shares of smaller companies and VCT shares could fall or rise in value more than other shares listed on the main market of the London Stock Exchange. They may also be harder to sell. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. This advertisement is not a prospectus. Investors should only subscribe for shares based on information in the prospectus, which can be obtained from octopusinvestments.com. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: April 2018