The Chancellor has cut VCTs a deserved break

Venture capital trust (VCT) managers and investors should not expect too much in the way of a Christmas present from Chancellor of the Exchequer Rachel Reeves. She has already been more than generous towards them.

As financial advisers start to think about end-of-financial year planning – and beyond – for their clients, that generosity could come in handy.

The first boon for fans of VCTs – tax-efficient investment trusts that take stakes in small, early-stage businesses – was the Chancellor’s promise in the Autumn to stick with the funds until at least 2035.

The VCT regime, which has just celebrated its 30th anniversary, is a temporary license to operate from the Treasury and this license must periodically be renewed. 

The fact that Reeves has given VCTs a 10-year-plus lease of life will soothe the anxieties of those who feared a Labour Government might not support the funds. The Chancellor’s largesse did not stop there. Many of her Budget changes make VCTs more attractive for significant numbers of investors.

Most obviously, the Budget increased capital gains tax rates – from 20% to 24% for higher-rate taxpayers – and the change took immediate effect. But all profits on VCTs are free of CGT, so there is now more reason to consider these investment trusts, particularly for investors who have already used up their ISA allowance, which also provides CGT protection.

On inheritance tax, meanwhile, VCTs are not exempt, which has been a headache for some investors with an interest in the Alternative Investment Market (AIM). VCTs can be a good way to build a managed exposure to AIM shares, but the fact that when held direct, AIM shares have largely been IHT-free gives pause for thought.

That issue will now be less relevant, because the Budget took away some of AIM’s IHT perks; VCTs now offer a tax-efficient route into AIM but will be at less of an IHT disadvantage.

Then there is the tax-free dividend income that VCTs offer. Even before the Budget, the annual dividend allowance – the amount of dividends you can earn from taxable investments – had been reduced to £500. That made sources of tax-free dividends even more attractive. Now, however, there is additional motivation for potentially millions of people to look at tax-free dividend income from VCTs.

Small business owners, who often pay themselves through dividends from their companies, are feeling the pressure of Budget changes such as increases to the minimum wage and employers’ national insurance. They may look to redress the balance by increasing their VCT holdings.

A recent Money Marketing column made exactly this point, with a case study of a business owner able to wipe out their dividend tax liability through careful use of VCTs and the 30% upfront income tax relief they provide – with the added bonus of the potential for ongoing tax-free dividends from the funds.

All of this comes with an important caveat. Shares in VCTs can fall in value as well as rise – and given that these funds almost exclusively invest in immature companies that are more vulnerable to failure, the risk of losses is higher than in other investment funds. That is why successive governments have been prepared to offer tax breaks.

Still, for financial advisers considering how to support clients in an environment where the tax burden is now rising – especially for business owners – VCTs offer all sorts of opportunities. For that at least, there is reason to raise a glass to the Chancellor for her recent announcements.
 

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