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Personal Finance - Benefits and risks of venture capital trusts

Investing in VCTs is high risk but you could make a large and untaxed capital gain, says Liz Willis.

(Photograph: Istock)
(Photograph: Istock)

Venture capital trusts (VCTs) are tax-efficient and are increasingly popular investment vehicles. They are not a suitable home for money you cannot afford to lose, but if they perform well, you may make a handsome profit that is free of capital gains tax (CGT).

VCTs invest in smaller companies, including start-ups and companies listed on the Alternative Investment Market (a sub-market of the London Stock Exchange, with a less stringent regulatory system than the main market). There is a risk that some VCT investments could fail completely.

Potential benefits
A reason for VCTs' surge in popularity is the recent changes to the pensions tax rules. Now anyone earning more than £130,000 a year will only receive 40 per cent tax relief on £20,000 of pension contributions, and any excess over this limit will only attract 20 per cent relief.

The minimum investment per person in a VCT is £3,000 per tax year and the maximum is £200,000. The minimum investment term is five years and you get 30 per cent tax relief upfront.

VCTs are exempt from CGT and there is no income tax to pay on any dividend income.

VCT fund managers aim for relatively high investment returns - often an average of 15 per cent or more per year.

However, VCTs normally only start paying tax-free dividends from year three onwards, so investors should not expect any return on their investment until year four.

More people, especially higher earners such as GPs, are considering VCTs as an alternative to pensions. After five years you can take your VCT proceeds and reinvest them in a pension for a further 20 per tax relief.

Enterprise investment schemes (EISs) are another investment aimed at helping small, higher-risk trading companies raise finance. They also offer tax breaks. However, the minimum investment is £50,000, putting them beyond the reach of most GPs.

As both EISs and VCTs are high risk, getting professional advice is essential before committing any money. Although they may produce a high return, you could lose every penny you invest.

My advice is to limit your contribution to around 20 per cent of your total wealth and bear in mind that the tax breaks could be withdrawn.

  • Financial adviser Liz Willis is a partner at the medical division, St James's Place Partnership, liz.willis@sjpp.co.uk
  • Minimum investment £3,000 per tax year; maximum, £200,000 per tax year.
  • Tax relief of 30 per cent in the year of investment.
  • Minimum investment term of five years.
  • No CGT on growth and tax-free dividend income.

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