VENTURE CAPITAL TRUSTS (VCTs) were given a boost last week when the European Commission approved new rules that will allow them to invest in a wider range of companies.
The trusts, which are designed to encourage investment in start-up firms by offering tax breaks to investors, are now “one of the most generous incentive schemes in Europe”, according to the Association of Investment Companies.
What is a VCT?
VCTs are companies that invest in small, higher-risk British firms with assets up to £7m. They offer 30% income tax relief on investments of up to £200,000 a year, as well as tax-free dividends and capital gains.
Their popularity has increased since the maximum annual allowance for tax-free pension contributions was cut from £255,000 to £50,000 in April last year.
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VCTs are listed on the stock market, so they can be bought and sold like shares. The investment must be held for at least five years to get the full tax benefit.
What has the government proposed?
It wants to encourage more people to invest in start-up companies and so proposed to change the size and types of businesses in which VCTs invest.
The plans, announced in the budget and autumn statement last year, included allowing VCTs to invest in larger companies, with assets of up to £15m, and with a greater number of employees, up from 50 to 250. The government also proposed raising the amount of money VCTs may invest in individual companies from £2m to £5m.
Why was there a problem?
European Union rules limit the level of government help that can be provided to small and medium-sized businesses. For example, the rules state that if any company in a state-aided investment scheme — essentially any investment that offers tax breaks — receives more than £2m funding in any 12-month period, investors will lose the reliefs.
What has the European commission decided?
The commission last week gave the go-ahead for Britain’s proposals, so VCTs now have the freedom to invest in larger businesses.
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The new rules also affect other forms of state-aided investment, including enterprise investment schemes (EISs) and seed enterprise investment schemes (SEISs), which offer tax breaks for direct investment in start-up firms.
Top tip
If you want to shelter more than the VCT limit of £200,000 from the taxman, consider an EIS, which offers 30% income tax relief on up to £1m. The investment must be held for at least three years, otherwise the taxman will claw back the rebate. EISs are also free from inheritance tax after two years, and payment of capital gains tax can be deferred until the shares are sold.
It is possible to invest in a portfolio of EIS companies through a fund. Patrick Connolly at AWD Chase de Vere, the adviser, likes the Oxford Gateway EIS Portfolio, which allows shares in up to 12 companies.
More adventurous investors could choose SEISs, which offer 50% relief, regardless of an individual’s marginal rate of tax, plus capital gains tax relief of up to 28% for any investment made using gains realised in this tax year — a total potential benefit of 78%. However, SEISs are high risk as they invest only in small firms, with gross assets of less than £200,000, at an early stage of their development.