FAQ's
What are the tax benefits if I invest in a VCT?
From 6 April 2007 if you buy new shares in a VCT:
- You will receive 30% income tax relief in the year that you subscribe
- Any dividends paid out by the fund will be tax-free
- Any capital gains arising on the disposal of the VCT shares will be tax-free.
For instance:
- A VCT investment of £10,000 would be eligible for 30% tax relief which effectively means the cost of the investment to you is £7,000.
- If you received £2,000 in dividends, you would keep the full £2,000 paying no tax.
- Finally, if you sold the shares for £11,000 you would not be liable for any capital gains tax on the £1,000 gain arising on the disposal.
When you make your VCT investment you will receive your share certificate and a tax certificate which you can include in your annual tax return in order to claim your tax relief. (Alternatively depending on the time in the tax year that you invest, you may be able to arrange with HM Revenue & Customs for an adjustment of your PAYE coding).
What are the conditions attached to a VCT investment?
- Your VCT shares must be held for a minimum of five years in order to qualify for the 30% income tax relief
- Although there is no upper limit on the amount you can invest in a VCT, the tax benefits are only available on the first £200,000 of investment in each tax year
- You can only claim income tax relief on your investment up to the amount of your total annual tax bill
- You need to subscribe for new shares of the VCT to be eligible for the 30% income tax relief - purchases of VCT shares in the market do not qualify for that income tax relief.
What will happen to my investment?
- The fund manager has three years in which to invest more than 70% of the funds raised in investee companies that meet the requirements of the VCT legislation and maintain that level of investment thereafter to retain its tax status and the tax benefits for investors.
- The fund manager can invest up to £1 million in any one company in any one tax year.
- During this three year period the uninvested cash is held in money market funds.
- Between 10% and 20% of the funds raised will be retained by the manager in order to make follow-on investments when appropriate. This reserve also enables the fund to offer a buy back facility for those shareholders who wish to sell their shares in the future.
- Your shares must be held for a minimum period of five years in order to retain the initial income tax relief received. Investors should consider VCTs as a long term investment.
- At Foresight we believe that a holding period of five to seven years should be considered when anticipating capital dividends (ie. trade sales or flotations), although earlier distributions can occur through income generated from the portfolio (ie. interest earned on a loan stock investment).
How should I choose which VCT to invest in?
There are three main types of VCT: AIM, Generalist and Specialist.
- AIM – investments are made in companies which are either already listed on the Alternative Investment Market or about to become listed. As these investments are in quoted companies, information is readily available and valuing the investment portfolio can be done quickly using the latest share price for the company.
- Generalist – these investments are usually in unquoted companies across a wide range of industry sectors and investment stages such as development capital, management buy-outs and, in some cases, early stage/seed capital.
- Specialist – these investments are made and managed by a manager who specialises in a defined investment sector. The stage at which the investment is made may vary depending on the perceived opportunity.
Some investors may want to divide their VCT investment between all three categories while others perhaps feel that they want the likelihood of more regular distributions with reduced risk and therefore opt for the Generalist option. The Specialist VCT may offer the investors access to potentially higher returns but with an increase in risk.
There are several independent websites which list existing VCTs and their performance: www.bestinvest.co.uk, www.taxefficientreview.com and www.taxshelterreport.co.uk.
Although previous performance is no guarantee to future investment success, attention should be paid to the fund manager’s track record, the dividend history of their other funds and, most importantly, the management team and how long they have worked together.
If you wish to track your investment on a regular basis you may also want to check that you will receive regular updates on the progress of the fund and ensure that the fund offers some form of investor relations service.
You may want to check whether the fund proposes to offer a share buy-back scheme for shareholders who may need to sell their shares. This enables you to sell your shares back to the fund – usually at about a 10% discount to the NAV.
What risks should I consider before making my investment?
- The value of shares in a VCT and the income from them can fluctuate and you may realise less than the amount you invest. In addition, there is no guarantee that the market price of VCT Shares will fully reflect their underlying net asset value or that you will be able to sell your VCT shares at that market price. Share buy-back schemes are offered by some VCTs enabling you to sell your shares back to the fund, usually at a 10% discount to the NAV.
- Your VCT investment will be used to support young and early stage business at the high-risk end of the market. This is where a portfolio approach can be beneficial in spreading the risk. Some of the investments will fail, some will perform adequately but the aim for a VCT fund manager is to have a few investments which produce excellent returns which will compensate for the losses and produce the returns to shareholders.
- You should regard an investment into VCTs as a long-term investment, particularly as VCT Shares need to be held for a minimum period of five years to retain the initial income tax relief.
- The levels and basis of VCT tax reliefs available to investors may change or be withdrawn at a future date.
- VCT status is only maintained if a VCT satisfies a number of continuing tests and there can be no guarantee that this can be achieved. In particular, a VCT must satisfy a requirement that, by the end of a period of three years from raising capital, its investments in qualifying companies represent at least 70 per cent of its total investments. A loss of VCT qualifying status within five years would result in investors having to repay tax reliefs obtained.
- Realisation of investments in unquoted companies can be difficult and may take a considerable time. There may also be constraints imposed on the realisation of investments in order to maintain the qualifying status of a VCT which may restrict its ability to obtain maximum value from its investments. Failures within the portfolio tend to occur fairly early on in the life of the fund and therefore this may result in the NAV dropping in the first couple of years. As the portfolio matures and the successful investments rise in value, the NAV should begin to rise to a level where distributions are able to be made to shareholders.
What if I need to sell my shares?
- If you need to sell your shares within five years of purchase you will have to repay the 30% tax relief.
- Due to the fact that the biggest tax benefit is payable at the time of purchase of your VCT shares and any secondary buyer would not be eligible for this, there is not a lot of market demand for second hand shares – although they do offer the buyer tax-free dividends going forward. Therefore most VCTs offer a buy-back facility which enable the shares to be bought back on behalf of the fund. The price for these shares is usually based around a 10% discount to the NAV.
- No capital gains tax is payable on the profit of your VCT shares.
What are the charges connected with a VCT?
- Initial set-up costs of the fund are usually 5.5% of the funds raised from investors.
- Annual management fees are usually between 2% and 2.5% of the VCT’s assets less liabilities.
- Total annual costs are usually capped at around 3.6% of the VCT’s assets less liabilities.
What happens to my shares if I die?
- Your VCT shares can be inherited in the same way as any other shares but there is no inheritance tax relief available on them.
- If you die within five years of buying your shares the initial tax relief obtained is not withdrawn.
- Once the shares are transferred to another name, the new holder will continue to receive tax-free dividends.
Glossary
Loan Stock
Loan capital ranks ahead of share capital for both income and capital. Loans typically are entitled to interest and to be treated as ‘qualifying loans’ must be repayable after the expiry of five years. Loans may be secured on the company’s assets or may be unsecured. A secured loan will rank ahead of unsecured loans and certain other creditors of the company. A loan may be convertible into equity shares. Alternatively, it may have a warrant attached that gives the loan holder the option to subscribe for new equity shares on terms fixed in the warrant. They typically carry a higher rate of interest than bank term loans and rank behind the bank for payment of interest and repayment of capital.
Preference Shares
These are non-equity shares. They rank ahead of all classes of ordinary shares for both income and capital. Their income rights are defined and they are usually entitled to a fixed dividend. The shares may be redeemable on fixed dates or they may be irredeemable. Sometimes they may be redeemable at a fixed premium. They may be convertible into a class of ordinary shares.
Ordinary Shares
These are equity shares that are entitled to all income and capital after the rights of all other classes of capital and creditors have been satisfied. Ordinary shares have votes. In a private equity deal these are the shares typically held by the management and family shareholders rather than the private equity firm.
NAV
The value of the fund's assets minus its liabilities.
Capital Dividends
Dividends paid from the VCT to shareholders as a result of the sale of all or part of the holding in an investee company.
Management Buyout
To enable the current operating management and investor to acquire or to purchase a significant shareholding in the product line or business they manage. MBOs range from the acquisition of relatively small formerly family-owned businesses to £100 million plus buyouts. The amounts concerned tend to be larger than other types of financing, as they involve the acquisition of an entire business. They tend to account for around 15% of financings undertaken each year by BVCA member companies.
Development Capital
Investment capital required by young but established companies to finance their growth.
Seed Capital
To allow a business concept to be developed, perhaps involving the production of a business plan, prototypes and additional research, prior to bringing a product to market and commencing large-scale manufacturing.
Start-Up
To develop the company’s products and fund their initial marketing. Companies may be in the process of being set up or may have been trading for a short time, but not have sold their product commercially.
Alternative Investment Market (AIM)
The second tier or junior market established by the London Stock Exchange in 1995 to provide trading facilities in the shares of smaller companies.
