Venture capital trusts

chucknorris

Does anyone have any experience of these? I am becoming increasingly curious about them, and I plan to learn more about them. Does anyone know:


1. If you invested say £20k, would that £20k be taken into account before your pension contribution is taken into account and therefore possibly reduce the amount of 40% tax relief that you could claim? Or is the pension contribution considered first?


2. I have read that limited life VCT's are perceived as being less risky, why is this? Is it because the companies are considered more viable because they have to fit criteria of reaching profitability in a shorter timeframe?

pip895

Not sure about the first question - I have always invested in the second hand market into well established and relativly liquid VCT's (e.g. Baronsmead). I think the limited life VCT's are considered less risky as you have a defined timescail for getting your cash out without risking the huge discounts that can open up with some of the open ended VCTs.

Reaper

You get 30% tax relief back regardless of what you are doing with pensions. It has no effect on your taxable income or pension tax relief.

bowlhead99

chucknorris wrote: »

1. If you invested say £20k, would that £20k be taken into account before your pension contribution is taken into account and therefore possibly reduce the amount of 40% tax relief that you could claim? Or is the pension contribution considered first?

As Reaper says, the tax relief is 30%. If you have used up some or all of your 40% band, it doesn't stop you claiming the 30%. However, the maximum amount of relief is limited to the actual tax you are paying. So for example, if you use pension contributions to get your effective taxable gross down to £30k, you will only be paying around £4k of income tax. If you then made an 20k investment in a new VCT issue, you would not be able to claim a full 30% (£6k) of relief, because you're only paying £4k in the first place. You could instead invest £10k in each of two tax years and get £3k twice.

2. I have read that limited life VCT's are perceived as being less risky, why is this? Is it because the companies are considered more viable because they have to fit criteria of reaching profitability in a shorter timeframe?

They are deliberately operating a strategy that they hope will enable them to exit the investments in an orderly manner and return the capital after a short life to maximise the "income tax relief per minute that your money's tied up". In order to do this they will have to ensure they don't invest in something illiquid with a high likelihood of being underwater when they intend to wind up.

Effectively they are looking to exploit the rules: deliberately trying to push the limit of the envelope of what HMRC will allow and still let you call it a VCT and get the tax break.

HMRC were originally trying to incentivise UK investment in Venture Capital (thus the name VCT) which is an inherently risky investment in smaller private companies (or perhaps the very small end of the listed world); something that requires you to commit to the investment for a decent period to allow the manager to find the opportunities and let them mature. The reason HMRC are incentivising it, is because without a tax benefit cushioning the blow of potential losses, people would be less likely to invest in the sector.

However some managers realised the public might like the chance to take a tax break, not really aim for a proper high risk/ high return long term investment, and then just cash out with low gains ASAP but still make money on the tax side. So, limited life products were born. If they're not managed correctly per the rules, they will lose their status and you will lose your tax break. If they're managed perfectly you'll make some tax free returns and a tax break.

What they won't be doing is investing for the medium to long term with a view to developing a bespoke long life portfolio in venture capital assets like a proper VC fund would do for an institutional investor such as a pension fund; the pension fund could not benefit from a tax break boost to returns, would like the assets to be deployed for a decent amount of time and would want a good underlying return to be developed.

By contrast a short-life VCT is a smash-and-grab raid to get a tax benefit for retail investors. It is not going to work if they go for a proper long-term investment plan accepting some initial costs developing the portfolio, some failures in the early years and a gradual improvement "the J curve" as the portfolio grows. They are not aiming to reach the long term and so will just try not to lose a huge amount within the confines of the scheme rules, and then hope the tax break makes you a winner overall.

I may be doing the limited life VCTs a disservice (as I have never tried to use one) but that is how I see it in a nutshell. I would rather find a manager who wants to make long term returns with the tax benefits being a perk on the side.

Of course, it does depend on what they mean by 'limited life'. Plenty of institutional venture capital, private equity/mezz or hedge funds are closed-ended with a limited life of 8-12 years (with provision for extension). But I wouldn't try to invest in smaller riskier companies with a time horizon of only 5-6 years to just grab a tax break. If they are doing a short life fund, and don't want to have you risk losing more cash to fees and investment losses than you gain from the tax break, you will be invested in pretty boring stuff which may qualify technically to be in a VCT but seems to be the antithesis of VC investing to me.

A recent thread on VCTs here https://forums.moneysavingexpert.com/discussion/5027294 , and a link to another one in my post on that thread.

chucknorris

bowlhead99 wrote: »

As Reaper says, the tax relief is 30%. If you have used up some or all of your 40% band, it doesn't stop you claiming the 30%. However, the maximum amount of relief is limited to the actual tax you are paying. So for example, if you use pension contributions to get your effective taxable gross down to £30k, you will only be paying around £4k of income tax. If you then made an 20k investment in a new VCT issue, you would not be able to claim a full 30% (£6k) of relief, because you're only paying £4k in the first place. You could instead invest £10k in each of two tax years and get £3k twice.
They are deliberately operating a strategy that they hope will enable them to exit the investments in an orderly manner and return the capital after a short life to maximise the "income tax relief per minute that your money's tied up". In order to do this they will have to ensure they don't invest in something illiquid with a high likelihood of being underwater when they intend to wind up.

Effectively they are looking to exploit the rules: deliberately trying to push the limit of the envelope of what HMRC will allow and still let you call it a VCT and get the tax break.

HMRC were originally trying to incentivise UK investment in Venture Capital (thus the name VCT) which is an inherently risky investment in smaller private companies (or perhaps the very small end of the listed world); something that requires you to commit to the investment for a decent period to allow the manager to find the opportunities and let them mature. The reason HMRC are incentivising it, is because without a tax benefit cushioning the blow of potential losses, people would be less likely to invest in the sector.

However some managers realised the public might like the chance to take a tax break, not really aim for a proper high risk/ high return long term investment, and then just cash out with low gains ASAP but still make money on the tax side. So, limited life products were born. If they're not managed correctly per the rules, they will lose their status and you will lose your tax break. If they're managed perfectly you'll make some tax free returns and a tax break.

What they won't be doing is investing for the medium to long term with a view to developing a bespoke long life portfolio in venture capital assets like a proper VC fund would do for an institutional investor such as a pension fund; the pension fund could not benefit from a tax break boost to returns, would like the assets to be deployed for a decent amount of time and would want a good underlying return to be developed.

By contrast a short-life VCT is a smash-and-grab raid to get a tax benefit for retail investors. It is not going to work if they go for a proper long-term investment plan accepting some initial costs developing the portfolio, some failures in the early years and a gradual improvement "the J curve" as the portfolio grows. They are not aiming to reach the long term and so will just try not to lose a huge amount within the confines of the scheme rules, and then hope the tax break makes you a winner overall.

I may be doing the limited life VCTs a disservice (as I have never tried to use one) but that is how I see it in a nutshell. I would rather find a manager who wants to make long term returns with the tax benefits being a perk on the side.

Of course, it does depend on what they mean by 'limited life'. Plenty of institutional venture capital, private equity/mezz or hedge funds are closed-ended with a limited life of 8-12 years (with provision for extension). But I wouldn't try to invest in smaller riskier companies with a time horizon of only 5-6 years to just grab a tax break. If they are doing a short life fund, and don't want to have you risk losing more cash to fees and investment losses than you gain from the tax break, you will be invested in pretty boring stuff which may qualify technically to be in a VCT but seems to be the antithesis of VC investing to me.

A recent thread on VCTs here https://forums.moneysavingexpert.com/discussion/5027294 , and a link to another one in my post on that thread.

Thanks for your very thorough response, there is a lot of info there, I will attempt to digest it all properly tomorrow.


I plan to retire next year at the age of 58, I won't actually draw any pension until I'm 66, but my rental income and dividend income will amount to about £85k (my wife also has similar income), and as I will only be able to invest £15k in a NISA and £3.6k in a SIPP, it opens the possibility to invest in VCT's. I have only just started to think about them. To be honest I was/am quite wary of the risks, and hence the questions about limited life VCT's. But my ideal scenario would be to build up long term tax free dividend income, so I suspect if I can get my head around the risk I may end up investing in a more long term strategy.

chucknorris

bowlhead99 wrote: »

HMRC were originally trying to incentivise UK investment in Venture Capital (thus the name VCT) which is an inherently risky investment in smaller private companies (or perhaps the very small end of the listed world); something that requires you to commit to the investment for a decent period to allow the manager to find the opportunities and let them mature. The reason HMRC are incentivising it, is because without a tax benefit cushioning the blow of potential losses, people would be less likely to invest in the sector.

I've read a bit more online and it's time to ask another question:


I can see the advantage in investing for the long term and obtaining a good tax free dividend income. But what about selling up when you reach that age that you need to get out (early 80's?). I've read that disposing of the shares can be difficult because the 30% incentive is not available to second hand buyers, do you have a strategy for that? Or do you consider that the years of tax free dividends more than compensates? What sort of a hit would you have to take to sell?

IronWolf

VCT's are risky, they will tend to have a few concentrated illiquid holdings and it is much harder to correctly ascertain their value. To invest in one you need to have a lot of confidence in the manager and accept the market price may not reflect is true value and so any exit could see you not getting a fair price.

chucknorris

IronWolf wrote: »

VCT's are risky, they will tend to have a few concentrated illiquid holdings and it is much harder to correctly ascertain their value. To invest in one you need to have a lot of confidence in the manager and accept the market price may not reflect is true value and so any exit could see you not getting a fair price.

That is the dilemma, go for limited life VCT (with an exit strategy) and hopefully mirror the limited tax free return of a NISA or invest for long term for many years of tax free dividends. I am still at the bottom of the learning curve though, so I have more to learn before I dip my toe in the water, the answer might be to do both.




EDIT: I have just thought of a possible 3rd option, what about buying second hand VCT's? You don't get the 30% tax relief but presumably you get a reasonable discount and possibly a better idea of how the shares are performing (again more research required).

Vortigern

Interesting thread.

Where would be the best place to buy VCTs? I believe HL give a discount on purchase and suggest that you might like to lodge your certificate in their Fund & Share account. (Custody fee?)

Cavendish Online seem to charge £35 to set up a VCT and offer to rebate their commission.

Is there a comparison site for VCT brokers?

... and which brokers do our experienced VCT investors use?

chucknorris

pip895 wrote: »

Not sure about the first question - I have always invested in the second hand market into well established and relativly liquid VCT's (e.g. Baronsmead). I think the limited life VCT's are considered less risky as you have a defined timescail for getting your cash out without risking the huge discounts that can open up with some of the open ended VCTs.

I didn't know what the second hand market was (still don't exactly) when I first read your post, but I'm becoming aware now. Could you tell me more about second hand CVT's?

Thrugelmir

chucknorris wrote: »

I can see the advantage in investing for the long term and obtaining a good tax free dividend income.

Part of the dividend income paid out may well be the repayment of capital as investments are liquidated. So don't base any decisions on yield alone. Very deceptive.