Darius McDermott: Three reasons to invest in VCTs ahead of the Budget

VCTs currently offer a very attractive combination of tax reliefs and, argues Darius McDermott, the potential threat the upcoming Budget poses to this set-up is a prime reason to buy into them now

The Autumn Budget is now just a couple of weeks away. Whether it is the excitement of playing along to ‘buzzword bingo’ or guessing the colour of the Chancellor’s tie – or perhaps you are even genuinely interested in what is being said – it remains one of the most highly anticipated events of the financial services sector’s year.

While Twitter tends to go mad with banter and people trying to be first to tell their followers what has been said, though, more often than not it can be a damp squib for investors. Having said that, occasionally a raft of changes are announced that will have positive and negative implications for our clients.

Ahead of the Budget announcement on 22 November, there has been some speculation that changes could lie ahead for venture capital trusts (VCTs). Investors in these vehicles currently benefit from a 30% tax break if they hold the shares for more than five years.

A paper published by HM Treasury in August, however, expressed concerns some VCTs are too focused on capital preservation, which is at odds with the UK government’s aim of encouraging new capital into higher-risk assets. As a result, there are rumours this 30% tax break could be slashed to 20%. As a consequence, a number of VCTs have begun to raise money ahead of the Budget.

For investors who do not yet have exposure to VCTs in their portfolios, what will this mean? And should they still consider buying this type of fund? I would say yes – provided, of course, it is suitable for their risk tolerance and overall financial goals.

Nearly every major provider is raising money right now, which is unusual. Occasionally a few may fundraise at this time of year, but normally the majority of activity takes place during the first quarter. This coincides with the end of the tax year when people are more incentivised to focus on tax-efficient products. To me, this is a signal they are sufficiently worried there is going to be a change to the tax relief.

Real advantage

Not only do VCTs currently offer 30% tax relief but any income or dividends that are paid from VCTs are also free of income tax. In addition, any gains made within the VCT are free of capital gains tax. So that all adds up to a real advantage – especially when you consider that the dividend tax allowance could be cut too.

Another point to consider is that VCTs invest across a range of asset classes, including AIM stocks and private equity, which can provide diversification within a broader portfolio.

Finally, the potential threat to this current tax relief set-up is a prime reason to buy into VCTs now. I particularly like the current offers from private equity fund Mobeus Income & Growth, Unicorn AIM VCT and Downing ONE VCT.

VCTs certainly make sense for people with high tax bills and an appetite for taking on risk. They would also need a long-term outlook as you need to hold VCTs for a minimum of five years to qualify for the tax relief.

VCTs are all about funding companies during their early stages of growth – and, in the process, providing investors with the potential to be rewarded well over the long term.

Darius McDermott is managing director of FundCalibre