COULD we all wipe out our tax bills by investing in small companies? This is the tantalising prospect held out by changes to the venture capital trust (VCT) regime brought in by Gordon Brown in the latest Finance Bill, enacted in July.
Next year, VCTs celebrate their tenth anniversary. But after a brief flurry of interest at the height of the stock market boom, they have not created the strong flow of new capital for fledgeling high-growth companies intended by John Major’s Government.
From the £450 million raised in the 2000-01 tax year, the amount garnered by these specialist small company trusts had dwindled to about £60 million last year. The reason is clear: VCTs, which are not to be confused with traditional investment trusts that invest in venture capital, were driven by tax incentives, particularly relief from capital gains tax (CGT).
The problem is that very few people pay CGT, even in good times. Fewer still have done so in the past, generally bloody, couple of years for the stock market. So after intense lobbying by the industry, Mr Brown allowed rule changes this year that have switched the main tax benefit of VCTs from capital gains to income tax (see facing page), at least for the next two years.
This should dramatically boost the market. A mere 170,000 people paid CGT last year, whereas 29.9 million people paid income tax. It means that about half the population could dramatically reduce, or even wipe out, their tax bills by investing in VCTs.
Advertisement
Even if you think that only higher-rate taxpayers should consider such esoteric investment vehicles (or have the spare cash to invest), the rule changes have made VCTs more attractive to an additional 3.5 million people. Andy Crossley, a fund manager with Invesco Perpetual, says that is ten times the number of investors in all the VCTs now on the market. “The tax advantages are so attractive that anyone who pays income tax should consider investing in them,” he says.
But Mr Crossley might well say that, because he is trying to raise £40 million for Invesco Perpetual’s first foray into the VCT market.
Sadly for him and the dozen trusts touting for business, Crossley’s enthusiasm seems not to have penetrated the consciousness of potential customers. He has had only
£3.7 million in subscriptions so far, which he believes represents about a third of all the money going into VCTs this tax year. But he is not downhearted, noting that people traditionally wait until the end of the tax year to invest.
Hugh Rogers, a VCT specialist at Bestinvest, the financial advisory group, says that many of the issues, such as the £4 million being sought by Robert Mitchell’s AIM VCT 2, are small top-ups to existing funds. They may, therefore, be subscribed quite quickly, so people need to move fast.
Advertisement
However, Martin Churchill, editor of Tax Efficient Review, which analyses tax-driven investment schemes, thinks it is too early to determine the success of the VCT changes. “Certainly, the supply is out there. We reckon that £450 million has either been launched or announced, but demand has not yet come through.”
Despite incentives being offered by sponsors, he recommends that potential buyers wait until the last moment.
In any case, the implications of the new rules will take a while to work through. David Knight, at the rival Tax Shelter Report, suggests the switch from CGT deferral to income tax write-off may make investors more inclined to sell their VCT shares than in the past. “The industry has to get its act together in the second-hand shares market,” he says.
Despite the slow start, even the more pessimistic voices are looking for the industry to elicit more than £300 million this year. The more bullish are predicting up to £600 million.
Whether or not such targets are met will depend on whether the industry can dispel the image of the VCT as a vehicle for the rich — and the rich that are ready to bear some pretty big losses. Net asset values of most VCTs are below, and sometimes well below, launch values. This means that the remaining assets in the funds are usually worth less than the cash first subscribed. Yet to get a full picture of returns, investors must take account of the (tax-free) dividends paid out over the years and tax breaks received at the time of the original investment.
Advertisement
The tax benefits depend on how much income and gains the individual was able to shelter, but taking just dividends and net asset values together, the results are not very edifying. A quick count from statistics provided by Tax Shelter Report shows that about 49 of the 73 trusts with records have seen negative returns since launch. Possibly the worst is the Downing Classic 2, which has lost about 65 per cent of shareholders’ money since it appeared in the 2000-01 tax year.
So uninspiring has been the performance of many funds that the UK Shareholders Association (UKSA), the lobby group, has launched a campaign to chivvy the industry into raising its game. It has criticised the performance of fund managers on a range of grounds from results to fees, transparency and the hefty discounts at which many of the shares trade.
It is initially targeting the Quester 3 VCT, a technology fund launched in the 1999-2000 tax year, which has shown a combined capital and income return of 46.3p a share, Tax Shelter Report says. The UKSA is in the process of sending a circular to all 2,100 investors in the fund, suggesting that they write to complain to the chairman.
But not all are so bad. Donald Maclennan, of VCF Partners, says that its Foresight Technology fund has paid tax-free dividends totalling 152p a share since launch, repaying the entire original investment 1.5 times over. Of those dividends, 52p a share was paid out to investors in July, thanks to the £44 million sale of Advanced Composites, maker of the carbon-fibre used in the British Olympic team’s racing bicycles. It just goes to show that, as in all investment, selectivity is vital.