Tax perks for VCTs under question

Specialists in venture capital trusts, tax-efficient funds that invest in small and unquoted companies, are predicting the tax perks of these funds could be watered down in the next tax year, following a very brief comment in the pre-Budget report on VCTs.

The industry had hoped the chancellor would have given firm guidance as to the future direction of tax reliefs on these funds.

Instead this was limited to just one sentence in the briefing papers accompanying Gordon Brown’s pre-Budget report. It said: “The government remains committed to ensuring the long-term sustainability and success of the VCT market, and will announce the future level of VCT reliefs at Budget 2006. The intervening period will allow further analysis of trends in the VCT market and continued dialogue with key stakeholders.”

Following a record year of sales for VCTs last year, which saw investors plough £520m into these funds and signs that investor interest could be equally strong this VCT season, some believe the generous income tax reliefs on VCTs will be reduced in the next tax year.

In the tax year 2004/5, Gordon Brown announced a temporary increase in the income tax relief on VCT investments from 20 per cent to 40 per cent, a move which led a massive resurgence in the VCT sector. This generous 40 per cent relief remains for VCT investments made in the current tax year.

But there are signs that some VCTs, having raised so much cash, are finding it tough to find enough decent investment opportunities.

Under Inland Revenue rules, VCTs have three years to invest 70 per cent of their fund assets in qualifying investments, mainly newly-issued shares in companies in approved sectors. However, a lack of suitable investments has caused some VCTs to break these rules, a move which could in theory lead to their tax perks being removed.

VCTs enjoy a number of tax breaks. In addition to all returns within a VCT being free of income tax and capital gains tax, investments in a VCT also attract income tax relief of 40 per cent, reducing the effective cost of a £100 investment to £60.

However, Martin Churchill, editor of Tax Efficient Review, which monitors the VCT market, believes this 40 per cent income tax relief could be reduced for the next tax year in next March’s Budget in an attempt to damp investor appetite for these funds.

He believes the income tax relief could be brought back down to 20 per cent, or it could even be brought down in stages, say to 30 per cent in the next tax year and to 20 per cent in the following tax year.

If these income tax reliefs are reduced, Churchill believes the Treasury could introduce other tax perks for investors to compensate, perhaps even exempting VCTs from inheritance tax after two years, in line with many shares listed on Aim, the junior stock exchange.