What is a VCT

What is a VCT?

Risk warnings for VCT Schemes

Individuals should always read and bear in mind the risk warning notices that are included within providers’ investment offer literature/documentation, including prospectuses, information memorandums, securities notes, brochures and other related marketing literature. Whilst the following list is not exhaustive, some of the main risks to be aware of include:

  • Investments are in small, unquoted companies and should be considered as high risk
  • An  investment in a VCTs should be viewed as a long-term investment and should only be considered if you can afford to tie up capital for long periods;
  • Legislation, along with the nature and level of tax reliefs is subject to change. There can be no certainty that investments will be eligible or remain eligible for VCT Relief;
  • Historic investment performance may not be a guide to future performance, and any given investment may fail completely causing you to lose the full amount invested;
  • Many VCTs involve investment in a single sector and therefore should only be considered as a small part of an overall portfolio;
  • Managers of VCTs will have inherent conflicts of interest as a result of inter alia existence of legacy holdings, investments in other funds managed by the same manager, the potential to earn performance related fees and the existence of different schemes with identical or very similar mandates;
  • VCT investments should only be undertaken by sophisticated investors who understand, and have given careful consideration to, the underlying investment strategy and associated risks.  For help in determining potential investment suitability, professional advice should be sought;
  • There can be no certainty that VCTs will continue to pay out their current level of income or indeed any income;
  • VCTs tend not to be very actively traded and can trade at a significant discount to net asset value; and
  • Investors will usually not be eligible for compensation if things go wrong.

A VCT is a company which invests in small unlisted companies. By investing indirectly (through VCTs) in a range of unquoted smaller companies, individuals can benefit from tax relief[1]. VCTs are similar to investment trusts and are also akin to publicly traded private equity vehicles. VCTs were previously companies listed only on the London Stock Exchange; since April 2011 VCTs have been companies admitted to trading on a regulated market[2].

VCTs were introduced by the UK Government in 1995 as one of the three tax-based Venture Capital Schemes (the others being the Enterprise Investment Scheme and the Seed Enterprise Investment Scheme), in order to provide a stimulus to small businesses in the UK by encouraging individuals to invest indirectly in a range of smaller unquoted companies.

TYPES OF VCT

There are two types of VCTs: limited life (or planned exit) and evergreen.

  • Limited life VCTs are those launched with the intention of winding-up after (at least) 5 years (minimum qualifying period). They aim to repay capital after at least 5 years.
  • Evergreen VCTs are those launched with no specific end date in mind. The majority of VCTs on the market are evergreen.

VCTs can also be categorised based broadly on their strategies. VCTs will either invest in unquoted companies (the majority) or in Alternative Investment Market (AIM)-listed companies.

  • Generalist VCTs

The majority of VCTs are generalist in nature. Generalist VCTs invest in a broad range of unquoted companies in different sectors and business stages with the aim of realising a profit when these companies are floated or sold.

  • AIM VCTs

AIM VCTs focus on the new shares of companies that are listed on London’s AIM stock exchange.  The manager selects target companies in which to buy and sell shares. However, as VCTs can only invest in new shares, the fund manager must ensure that offers are received from as many brokers as possible. Normally the investment is limited to ordinary shares so there will be no certainty of income in the short term. However, when the quoted prices of shares in investee companies rise the manager can take capital profits and distribute these to the shareholders.

  • Specialist VCTs

As the name suggests, specialist VCTs focus their efforts on one sector that they have extensive knowledge of, such as technology or media. Their inherent lack of diversification makes them generally higher risk, although if their focused investment goes well they have the potential to make very good returns.

Life-cycle of VCT portfolio companies:

VCTs invest in companies at various stages of their life-cycle depending on the strategy that the VCT Manager is pursuing, including seed stage, venture/early stage, development and growth stage.

1. Investors are exempted from Income Tax on dividends from ordinary shares in VCTs (also known as dividend relief). Income Tax relief at the rate of 30% of the amount subscribed for shares issued in the tax year 2006-07 and onwards (for subscriptions for shares issued in previous tax years the rate is 40%). Investors can get Income Tax relief for a tax year if shares in VCTs for which they subscribed up to a maximum of £200,000. For more details please go to www.hmrc.gov.uk.
2. A regulated market is one named as such by the EU, covering markets in EU and EEA countries.

Changes following the 2015 summer finance bill:

The summer finance bill 2015 introduced several new restrictions on VCTs:

  • 1) the lifetime allowance of tax advantaged funding that an investee company can receive was capped at £12 million unless the company is ‘knowledge intensive’ in which case the cap is £20 million;
  • 2) VCT’s can no longer invest in business’ once 7 years have elapsed since their first commercial sale with this extending to, 10 years should the business be deemed ‘knowledge intensive’. N.B. this will not apply where the investment represents more than 50% of turnover averaged over the preceeding 5 years;
  • 3) VCT’s will no longer be able to reinvest monies raised from exits in business that were previously eligible at the time of funding into similar transactions.
  • 4) The previous requirement for 70% of Seed Enterprise Investment Scheme (SEIS) money having to be spent before VCT funding can be raised has been lifted.

As of yet the definition of ‘Knowledge intensive’ is undefined by HMRC.
Types of Offerings:

  • New Issues — A new VCT seeking to be listed on the London Stock Exchange.  It requires new capital.
  • Top-up Offer — The VCT is already listed on LSE and is seeking to raise more capital.  This VCT will have access to a mature portfolio and a possible dividend stream.
  • Linked or Joint Offer — Multiple VCTs, managed by the same manager, seeking to raise capital under the same offer.

 

VCT TAX RELIEF

It is important to note that tax reliefs are only available to individuals aged 18 years or over. In order to qualify for income tax relief, certain criteria must be met:

  • The shares must be new ordinary shares and must not carry any preferential rights or rights of redemption at any time in the period of five years beginning with their date of issue.
  • An investor must have subscribed for the shares on his/her own behalf, the shares must have been issued to him/her, and he/she must hold them for at least five years.

Summary of Tax Benefits

Tax Efficient Comparison Table EIS SEIS BR IHT VCT
Current Investment Limits  £1 million (A) £100,000 (D) No limit £200,000
Capital Gains Deferral Up to 28% (B) n/a n/a Nil
Capital Gains
Re-investment Relief
n/a Effective relief up to 14% (E) n/a Nil
Income Tax Relief 30% 50% n/a 30%
Min Holding Period 2 years for IHT
3 years for EIS
2 years for IHT
3 years for SEIS
2 years 5 years
IHT Free Yes after 2 years Yes after 2 years Yes after 2 years No
Tax Free Exit Yes/No (C) Yes after 3 years Yes, after 2 years Yes
Secondary Market No No No Yes
Loss Relief Yes Yes N/A No
Carry Back Facility Yes Yes N/A No
Tax Free Dividends No No No Yes
Business Relief 100% after 2 years 100% after 2 years 100% or 50% after 2 years (F) No

(A) Up to £1 million of EIS investment may be carried back to the previous tax year if the limit for that year was not fully utilised.
(B)Gains arising in to higher rate UK tax payers are chargeable at 28%. The relief is a deferral only, and not an exemption and the deferred gain will crystallise on sale of the EIS shares.
(C) There is no tax free exit for shares for which EIS deferral relief only was claimed.
(D) Up to £100,000 of SEIS investment may be carried back to the previous tax year if the limit for the year was not fully utilised.
(E) SEIS reinvestment relief exempts half of the gain reinvested up to the SEIS maximum investment of £100,000 ie for a gain of £100,000 reinvested in an SEIS investment, £50,O00 of the reinvested gain is exempt
(F) A business or an interest in a business – 100%
Unquoted securities which on their own or combined with other unquoted shares or securities give control of an unquoted company – 100%
Unquoted shares – 100%
Quoted shares which give control of the company – 50%
Land or buildings, machinery or plant used wholly or mainly for the purposes of the business carried on by a company or partnership – 50%
Land or buildings, machinery or plant available under a life interest and used in a business carried on by the individual  -50%

 

The following table summarises the VCT tax relief evolution history.

Tax Year 1995/96 ~ 1998/99 2000/01 ~ 2003/04 2004/05 ~ 2005/06 2006/07 ~ Present
Rate of income tax relief on subscription 20% 20% 40% 30%
Minimum VCT holding period to qualify for income tax relief 5 years 3 years 3 years 5 years
Maximum investment eligible for income tax relief per year  £200,000  £200,000  £200,000  £200,000

Source: HMRC

There are also income tax implications if an investor sells or otherwise disposes of his/her shares within 5 years of the issue date. For more information, please see  http://www.hmrc.gov.uk/guidance/vct.htm#4.

SECONDARY MARKET

As VCTs are quoted on the stock exchange, in theory it is possible to sell the shares in the VCT to other investors. However, VCT shares may be difficult to sell as VCTs are illiquid investments and investors should bear in mind that the invested capital is locked in. This is mainly because the 30% income tax relief only applies to the purchase of new shares and as a consequence no active secondary market has developed. In addition, shares usually trade at a discount to the net asset value (NAV). The average stockbroker is therefore unwilling to take VCT shares and the price will typically be unattractive. There are however two main options for investors:

  1. Investing in VCTs with a buy-back policy. Investors should receive a price at around a 5-10% discount of the NAV.
  2. Investing in limited life VCTs.

Risk warnings for VCT Schemes

Individuals should always read and bear in mind the risk warning notices that are included within providers’ investment offer literature/documentation, including prospectuses, information memorandums, securities notes, brochures and other related marketing literature. Whilst the following list is not exhaustive, some of the main risks to be aware of include:

  • Investments are in small, unquoted companies and should be considered as high risk
  • An  investment in a VCTs should be viewed as a long-term investment and should only be considered if you can afford to tie up capital for long periods;
  • Legislation, along with the nature and level of tax reliefs is subject to change. There can be no certainty that investments will be eligible or remain eligible for VCT Relief;
  • Historic investment performance may not be a guide to future performance, and any given investment may fail completely causing you to lose the full amount invested;
  • Many VCTs involve investment in a single sector and therefore should only be considered as a small part of an overall portfolio;
  • Managers of VCTs will have inherent conflicts of interest as a result of inter alia existence of legacy holdings, investments in other funds managed by the same manager, the potential to earn performance related fees and the existence of different schemes with identical or very similar mandates;
  • VCT investments should only be undertaken by sophisticated investors who understand, and have given careful consideration to, the underlying investment strategy and associated risks.  For help in determining potential investment suitability, professional advice should be sought;
  • There can be no certainty that VCTs will continue to pay out their current level of income or indeed any income;
  • VCTs tend not to be very actively traded and can trade at a significant discount to net asset value; and
  • Investors will usually not be eligible for compensation if things go wrong.

1.Investors are exempted from Income Tax on dividends from ordinary shares in VCTs (also known as dividend relief). Income Tax relief at the rate of 30% of the amount subscribed for shares issued in the tax year 2006-07 and onwards (for subscriptions for shares issued in previous tax years the rate is 40%). Investors can get Income Tax relief for a tax year if shares in VCTs for which they subscribed up to a maximum of £200,000. For more details please go to www.hmrc.gov.uk.

2.A regulated market is one named as such by the EU, covering markets in EU and EEA countries.