Rachel Reeves used one of her final acts as Chancellor to cut the tax breaks available to investors in venture capital trusts (VCTs), reducing income tax relief on new investments from 30 per cent to 20 per cent. Despite the move, which critics say sits awkwardly with the Government's stated wish to get people investing more in British businesses, investment commentators say the trusts can still play an important role in long-term financial planning.
For income-seekers in particular, VCTs can provide tax-free dividends to complement income from pensions and Isas, and can also help mitigate tax bills. But investing in them is high risk, and capital returns can be hit if any of the unquoted companies a VCT holds fail.
Alex Davies, founder of investment service Wealth Club, said VCTs give investors the chance to become an angel investor and back some of the country's most promising start-up businesses, naming digital health company Oviva, London-based AI and data analytics software firm Quantexa, and fintech company OpenTrade. "But they are high risk," he said. "Look beyond the attractive tax breaks because they are just the icing on the cake. The underlying investments need to make sense and you should spread your money across different VCT managers."
What is a VCT?
VCTs provide finance to fledgling companies. The trusts themselves are listed on the London Stock Exchange, but the businesses they invest in are not, they are unlisted, private and often embryonic. Most have assets of no more than £30million, a fraction of the more than £200billion held by BP. Major investment houses running VCTs include Albion Capital, Foresight Group, Maven Capital Partners and Octopus Investments.
Three tax breaks
Investors are drawn to VCTs through three key tax breaks. The first is 20 per cent income tax relief on an investment of up to £200,000 in the current tax year, down from 30 per cent in the previous tax year after Reeves' cut. On a £50,000 investment, that relief is worth £10,000, which can be set against an investor's income tax bill and at best wipe it out entirely.
The relief only applies to new shares issued by a VCT as part of a fundraising round, not shares bought on the stock market. The current fundraising season has just begun and runs until the end of the tax year in April. Investors must then hold the shares for at least five years; selling earlier, for example to cover a financial emergency, means the taxman claws back the relief.
Second, any capital gains from the investment escape capital gains tax, which Chancellor John Healey is likely to raise in next month's Budget. Commentators note that capital profits from VCTs tend to be modest, with most of the return coming from dividends instead.
Tax-free income
Figures from the Association of Investment Companies show the average VCT delivered a share price total return, combining capital and income, of 14 per cent over the past five years and 37 per cent over ten years. Trusts with the best ten-year records are run by Albion, Gresham and Foresight.
Research by Chelsea Financial Services for this newspaper found that 13 of 29 VCTs have paid out total tax-free income equivalent to at least 70 per cent of their 2016 asset value over the past decade. Albion Enterprise VCT paid dividends totalling 71.95p over ten years, nearly 75 per cent of its 96p-a-share 2016 asset value, driving a total return of 133 per cent assuming dividends were reinvested.
Peter Hicks, research analyst at Chelsea, said the past decade had brought seven prime ministers and seven chancellors, with the country responding to Brexit, the pandemic, artificial intelligence and trade wars. "Despite all of this, the VCT sector has held true, maintaining an impressive consistency in delivering tax-free income to investors," he said.
Who should buy them
Sarah Coles, head of personal finance at investing platform AJ Bell, said the high risk attached to VCTs means they suit only experienced investors with substantial existing holdings across pensions and Isas. She said just short of 22,500 investors claimed income tax relief on VCTs in the tax year ending April 5, 2025, compared with 15 million adults who paid into Isas the previous year.
Jason Hollands, managing director of Bestinvest, part of wealth manager Evelyn Partners, agreed, saying VCTs should be considered by a relatively small group of investors, namely high earners facing significant income tax bills who have already used up their annual Isa and pension allowances.
Davies said anyone who cannot afford to lose the money they are investing, or is uncomfortable having money locked up for a long time, should not buy VCTs, which are not a substitute for a pension, emergency savings fund or low-risk income portfolio.
How to buy them
Several established VCT managers are raising, or about to raise, money for their funds, including Albion, British Smaller Companies and Pembroke. Buying shares at a fundraising, rather than on the stock market, is what entitles an investor to the 20 per cent tax relief. Details of current offers are available from major investing platforms and specialists such as Chelsea and Wealth Club.
Davies said VCTs offer different flavours of exposure to small companies with growth potential, so investors should spread money across different managers and ensure the VCTs they choose are invested in a decent number of companies. "That gives you a lot of shots on goal," he said.
