I expect Chancellor Gordon Brown to kill off Britain's best tax break
in this year's Budget. So promoters of VCTs anticipate a huge inflow of
funds before the 5th April deadline. But advisers warn that the 40p-in-the-£1
rebate should only be used by investors prepared for a rollercoaster ride.
Venture Capital Trusts are expected to raise over £700 million from investors
before April 5th, when the current 40% tax relief on new investments is likely
to come to an end.
Some experts caution that as a result of this inflow on top of last year's
£500 million, there may be too much money chasing too few good investment
opportunities.
The 40% tax relief was introduced for the 2004-05 and 2005-06 tax years, and
we will learn on Budget Day in March whether it is to be extended. But with
Gordon Brown under huge pressure to cut spending or raise taxes, I will be amazed
if he extends this perk for affluent investors.
The way the relief works is that you get an income tax rebate at the rate of
40% of the amount you invest, with an upper limit of the amount of income tax
you have actually paid during the year or a maximum investment of £200,000.
So if you have paid £10,000 of income tax you could invest £25,000
in VCTs and get it all back. The net effect is that a £10,000 investment
will actually cost you £6,000.
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on investing in a VCT
Who should invest in VCTs?
This sounds great and indeed it is the best tax break going for UK taxpayers,
especially when you take into account that all gains from VCTs are tax-free
and so are all the dividends they pay. But there are also some big buts you
must take into account:
1. You must hold the shares for a minimum of three years; if you sell earlier
the tax rebate will be clawed back. The market in VCT shares is very illiquid,
so if you do want to sell you may get a poor price.
2. VCTs invest either in businesses listed on the AIM market, or in start-ups
- all of which are far riskier than other types of share.
3. Annual charges are far higher than for other types of fund, typically 3%-4%.
VCTs are only really a suitable investment for people who already hold other
investments, are prepared for the higher risk inherent in VCTs and are willing
to hold the shares for a minimum of five years.
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How a loser can still be profitable
That is the downside, but some advisers are a little more upbeat. They point
out that since a £1 share actually costs you 60p, the managers can make
a lot of mistakes before they lose 40% of your money. In other words, you only
need a very modest rate of return on the investments to come out with a healthy
return thanks to the tax break. Say the £1 share is still only worth £1
after five years. Since it cost you 60p, you have actually made an annual return
of 10%, which is of course net of tax. Even if the shares were worth under £1
you could still be making a reasonable profit on your real net investment.
A few advisers go further and compare VCTs with contributions to pension funds.
When you invest in a pension fund you get tax relief at your marginal rate,
which could be 40%, but when you take money out as retirement income you pay
tax on it at 40%. In contrast, a VCT can provide an ongoing stream of tax-free
income. For those planning to retire in, say, five years' time, this is
interesting, especially since low interest rates mean you now get a very poor
return when you convert your pension fund into an annuity income.
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Costs are a concern
My big reservation with VCTs is not so much the risk, which is probably in many
cases not that much greater than investing in AIM shares, but the costs. Most
VCTs have an incentive scheme where the managers keep a fifth of all the profits
they make over a set level - and this on top of their annual management charges.
Some have added even more in the form of ‘sweet equity', whereby
managers are allowed to buy into the companies the VCT invests in - which amounts
to getting a free ride on your money.
VCTs' annual costs of up to 4% are justified by managers in terms of
the manpower needed to research and fix the deals, but big old venture capital
trusts like 3i used to operate with annual charges at half this level. It's
hard not to conclude that managers are just grabbing a sizeable chunk of the
tax break for themselves.
Still, the tax incentives are attractive and advisers reckon the final total
of this year's launches will easily top £700 million. Indeed, some
are saying that many VCTs are likely to reach their maximum subscription levels
and close well before April 5th.
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on investing in a VCT
Four of the best
Here are four VCTs I think are worth looking at:
- Unicorn AIM VCT2: This fund is run by small company star investor
Peter Webb. The only worry being that his investment performance has drifted
off in the past 18 months. But I think he's likely to do as well as
anyone with a list of AIM companies.
- Foresight 3 VCT: Foresight are specialist technology investors, so
if you want big-bang-bucks, this is the one for you.
- Northern Ventures C: Northern are much more gritty and traditional;
the money will be widely spread in a range of different types of young business.
They have a decent track record.
- Close Technology & General VCT C: Close have been pretty good
at VCT investing, and this one balances a small commitment to technology with
a larger slug of lower-risk businesses.
If you do invest in VCTs, be sure to spread your money across two or three
different funds to limit the risk. Most funds have a minimum of just £3,000.
You should seek advice before investing in VCTs.
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Important risk warning - please read
The value of your investment and the income from it can go down as well as up
and you may not get back a significant proportion of your investment. Past performance
is not an indication of future performance. If you are in any doubt as to the
suitability of an investment, you should seek independent financial advice.
