VCT guide

7 RISKS AND REWARDS Investments into unquoted small and medium- sized enterprises are deemed high risk. The value of smaller companies can rise and fall more sharply than that of more established businesses and investment returns will typically be more variable. It is important to understand the key risks associated with VCT-qualifying investments in a general sense, and we will examine some of those risks here. However, each individual VCT will have its own unique risks and, therefore, each VCT must be individually assessed. Investment risks Statistically speaking, smaller companies fail more often than larger, more established ones. The reasons for this include: • They may be more reliant upon a small number of customers. • They have less capital available to withstand a downturn in fortunes. • They can take a long time to bring new initiatives to fruition and become profitable. • Where they are listed on AIM, they can experience significant share price volatility. These risks can be offset to some extent by measures, including: skilful stock selection and sufficient diversification; and, where Risks and rewards possible, investing in more mature companies with existing customers and assets (to the extent that this is permissible under the new ‘risk-to-capital’ condition), or by a combination of both of these strategies. VCTs can use gearing (borrowing money to invest), which can magnify risks (as well as returns). However, the use of gearing within VCTs is extremely rare. Liquidity VCTs are investment companies and investors can sell their shares on whichever market the VCT is listed on, predominantly the LSE. In addition, up to 20% of the VCT’s assets (up to 30% for accounting periods ending before 6 April 2019) may be held in cash, or certain other liquid assets. However, liquidity can still be problematic. VCTs’ shares are not widely traded and they usually trade at a discount to their Net Asset Value (NAV). VCT managers do often offer share buyback schemes to enable divestment, but these are usually at a discount to the underlying asset value and are not guaranteed. Although the minimum holding period to qualify for and retain income tax relief is at least five years (note, there is no minimum holding period for Capital Gains Tax (CGT) disposal relief and tax-free dividends – although these are subject to the permitted maximum), in reality investors are likely to have to commit their funds for much longer; most VCT investments should be viewed on a five to ten-year investment horizon. Some VCTs were previously positioned as ‘limited life’ or ‘planned exit’ and had an objective of winding up as soon after the five- year minimum holding period as possible. However this was still subject to being able to successfully dispose of the qualifying investments (without there being any arrangements in place to sell the assets from the outset, which would impede qualification for the tax reliefs). Tax risks In order to qualify for the tax reliefs, VCTs must follow a number of rules. The rules govern: • The types of investments that they make; • Howmuch cash they can retain within the fund; • How quickly they have to deploy any funds they raise. If the VCT breaches any of these rules, it may lose its approved status and investors would risk having their tax relief withdrawn and clawed back by HMRC. The specific rules will be explained further in the ’Rules for VCTs’ section which starts on page 15. The changes announced in the Autumn Budget 2017 mean that, over time, all VCTs will hold less cash and liquid resources than they may do currently. VCT HOLDING PERIOD Potential growth Years 0 1 2 3 4 5 6 7 8 9 10 Statutory 5-year holding period More likely investment horizon VCT investment VCT tax reliefs in summary VCT tax reliefs are only available to investors with a UK tax liability and are only available if the VCT maintains its qualifying status with HMRC. The amount of relief an investor will be entitled to depends on their individual circumstances. While it is important to understand the details of the tax reliefs available, tax should not be the only driver for investment in shares in a VCT. The investment must be suitable for the client even without taking tax relief into consideration and there is likely to be a specific planning scenario involved. There are THREE potential tax reliefs available for VCT investors, some or all of which may be available/applicable to a particular investor. INCOME TAX RELIEF: Up to 30% income tax relief (subject to the permitted maximum investment amount of £200,000 p.a. and five-year minimum holding period). TAX-FREE DIVIDENDS: 100% income tax relief on dividends (subject to the permitted maximum). TAX-FREE CAPITAL GROWTH: Subject to the permitted maximum.