Venture Capital Trusts: a great tax shelter

Prime minister-elect Gordon Brown has been the subject of a fair amount of criticism for widening the tax burden on UK citizens, but one development deserving of consideration for business entrepreneurs and investors alike is the creation of tax-break schemes such as the Enterprise Investment Scheme and Venture Capital Trusts.

Qualifying businesses (in Labour terms, this excludes property development and certain financial services and trading) already benefit from business taper relief when it comes to the sale of the business, which allows a ten per cent tax payment on any monetary gain as opposed to forty per cent under previous policy. This measure has been cited as one of the reasons that many business owners stay in the UK rather than relocating to places like Jersey to become tax exiles.


What is a VCT?

Tax for individuals investing in small businesses underwent a similar reformation with the emergence of the EIS, concerning investments in single companies, and VCTs, quoted investment trusts investing in a portfolio of qualifying companies. Both schemes originally had very similar tax breaks, with forty per cent tax deferral in the form of capital gains rollover relief, and twenty per cent income tax relief.

The more high profile of the two, stock market quoted VCTs, have undergone a number of changes since inception. In 2004 the terms mentioned above became instead a straight forty per cent income tax refund, with over £1.5 billion raised by a variety of funds in the two years that the regime remained. Last year this relief was reduced to thirty per cent, and restrictions were installed for the new tax year stipulating that new money raised by the trusts must be limited to investment in companies employing less than fifty people, with a ceiling of £2 million of funds to be injected.


What's in it for the investor?

Although the VCT scheme is considered by most to be in keeping with Brown's policy of closing the 'equity gap' by helping small high-risk businesses raise venture capital, commentators have ventured the opinion that the negative implications for the small company sector brought by 2006's changes will kill interest in VCTs. On the other hand, measures taken to cut back on tax breaks available for films and related industries have resulted in singling out VCTs as one of the few areas left where tax can be sheltered.

Despite track records significantly more positive than the press has credited, VCTs can be off-putting when the initial time and cost investments in setting up and raising funds is to be considered. Added to this, they have a reputation for 'hockey stick' returns, with an average four or five years for portfolios to mature. The balance however is resettled by the fact that once a fund is underway, its dividends remain tax free. The reduction in funds raised potentially means that there are plenty of opportunities for the investor.


Is a VCT as effective for businesses?

For entrepreneurs, VCTs also come with their share of negative press. One of the main criticisms is based around the fact that VCTs often expect a place on the board, and with a reputation for a ruthless focus on returns and a lack of interest in areas like company culture and entrepreneurial flair. Timescale can be another contention, as investors qualify for tax breaks after three years, perhaps creating pressure on the investee company to be sold more quickly than its directors would deem suitable.

Looked at from another point of view however, the addition of a detached observer to the board can often provide valuable independent advice, helping to promote company growth. VCT investors can bring with them a range of useful contacts, and the right individual can even add a degree of creditability to the business, attracting further investment.

With a present total of 80 Venture Capital Trusts and a fund bank of £150 million, providing that companies can select wisely and end up with the right investor on board, a VCT can certainly prove an excellent opportunity for investors and entrepreneurs alike.

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