VCTs
Established by the UK government in 1995, VCTs are an investment vehicle that allow retail investors access to investment in smaller, high-growth businesses while benefiting from significant tax reliefs.
VCTs are publicly traded companies on the London Stock Exchange, structured to collect funds from investors buying shares in the VCT. These funds are then invested in qualifying, unlisted companies, providing capital for growth and development. A type of investment trust, VCTs are managed by professional fund managers, who select and manage a varied portfolio of investments, focussed on high-growth, innovative sectors.
Through investing in a VCT, individuals have exposure to a range of smaller, unquoted businesses that may otherwise be beyond their reach. The UK Government's recent 10 year extension of the VCT legislation strengthens the entrepreneurial ecosystem by promoting economic growth and innovation, while incentivising investors with significant tax benefits.
Tax benefits of VCTs
VCTs offer investors a variety of potential tax benefits to qualifying investors:
- Income Tax Relief: Individuals can claim up to 30% income tax relief on investments of up to £200,000 per tax year, provided the shares are held for at least five years. The tax relief scheme offers significant savings, encouraging long-term investments and supporting SMEs. However, investors must be comfortable that they will need to hold the VCT shares for at least 5 years and also ensure they are fully eligible and compliant with legislation, as this relief is subject to restrictions.
- Tax-Free Dividends: Dividends received from VCTs are exempt from income tax, making them an attractive source of tax-free income. However, investors should consider the risks associated with VCTs, such as potential capital loss and the limited liquidity of VCT shares (particularly with the 5 year holding requirement for income tax relief). Funds will have different investment policies and track records, and a proper understanding of each VCT's risk profile is crucial.
- Capital Gains Tax (CGT) Exemption: Any gains made on the disposal of VCT shares are free from CGT, provided the shares were acquired within the annual investment limit. However, investors must be mindful that VCT investments do not guarantee gains in value, so this exemption does not guarantee profits.
These tax incentives are designed to offset the higher risks associated with investing in early-stage companies, and encourage long term capital investment. This makes VCTs a potentially appealing option for investors looking to diversify their portfolios and support the growth of smaller UK businesses.
Qualifying conditions for VCT investment
A VCT is permitted to invest in specific, qualifying companies. The list of rules around qualifying investee companies is non-exhaustive, but some key considerations include:
- Unquoted: The company must not be quoted, although its shares may be traded on the Alternative Investment Market (AIM).
- Employee Limit: The company generally must have fewer than 250 full-time employees, although if the investee company is a parent company, then the number of employees of each qualifying subsidiary of the parent must be within the limit. The limit also depends on whether the company is 'knowledge intensive', where the limit is 500 full-time employees.
- Gross Assets: The company’s gross assets must not exceed £15 million before investment from a VCT and no more than £16 million immediately afterwards.
- Trading Activity: The company must be engaged in a qualifying trade, which includes a wide range of activities, with several exceptions, including:
- Dealing in land, shares or commodities;
- Financial activities;
- Property Development; and
- Farming.
- Age of Company: The company must receive its first risk finance investment within 7 years of its first commercial sale, or within 10 years for a 'knowledge intensive' company. The definition of a first commercial sale excludes limited sales to test the market.
The regulations surrounding VCT qualifying companies is designed to benefit SMEs but is a complex arena to navigate. The relevant definitions and qualifying conditions should be checked with a professional adviser on each occasion. As such, it is crucial to consider obtaining professional advice regarding whether your company is eligible for VCT investment.
Investment strategy
VCTs typically focus on sectors like technology, healthcare, and renewable energy, showcasing the evolving landscape of emerging industries. This diversification helps mitigate risks associated with early-stage companies. By spreading investments across high-growth sectors, VCTs aim to capture potential upsides, enhancing overall returns. They often focus on companies with strong growth prospects and innovative solutions, increasing the prospect of substantial returns for investors.
VCTs provide investees with crucial funding to fuel their growth and innovation. By offering a steady source of capital, VCTs enable early-stage companies to scale their operations, develop new products and expand into new markets.
DWF has a market leading venture and growth capital practice in the UK, supporting investors and companies across several sectors including financial services, technology, media and telecommunications, life sciences and healthcare and real estate and infrastructure. If you have queries on any of the issues covered in this article please contact one of our experts: Dhruv Chhatralia BEM, James Bryce, Caroline Colliston (as the tax representative for the corporate articles), Darren Ormsby, Gemma Gallagher, Gary MacDonald, Paul Pignatelli, Scott Kennedy, Will Munday, Alex Stoughton, Francesca Kinsella, Graham Tait and Rosie Spencer.
