Tax rises drive surge in venture capital trust investment

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Retail investors are ploughing money into small British companies as they seek out tax-efficient products in the wake of Labour’s general election win and the biggest tax rise in the postwar era.

Savers sank £250.1mn into venture capital trusts (VCTs) from the start of the tax year to mid-November — a 26.6 per cent increase on the previous year according to figures from Wealth Club, an investment service.

In last month’s Budget, chancellor Rachel Reeves raised the tax burden to its highest level since the 1950s, announced that pensions would no longer be exempt from inheritance tax and raised capital gains tax.

“Generally, as tax rules get tighter on pensions, the money has to find a home somewhere else and often it goes into VCTs,” said Alex Davies, chief executive of Wealth Club.

The VCT scheme, extended this year until 2035, allows individuals to invest in early-stage businesses via actively managed VCT funds.

Investors are rewarded with income tax relief of up to 30 per cent on up to £200,000 a year — provided they purchase shares at issue and hold them for at least five years. Dividends and capital gains are tax-free.

VCTs have previously backed household names such as the property platform Zoopla and the UK arm of the Five Guys burger chain.

On Friday, investment platform Hargreaves Lansdown launched a new online VCT investment service, citing the government’s extension of the scheme and tax changes announced at the Budget, which included raising capital gains tax from 20 per cent to 24 per cent for higher earners.

Hargreaves’ service will debut with a group of five VCTs managed by Calculus Capital, Octopus Investments and Blackfinch Ventures. Clients will pay a £50 dealing charge to apply for the VCT service and a subsequent £50 fee to trade. Hargreaves will not take commissions or charge platform fees.

Emma Wall, head of platform investments, said the government had provided “assurances” it would retain the structure and tax efficiency of VCTs.

Venture capital trusts offer the prospect of higher returns than other assets, but come with greater risk and low liquidity.

Paul Stewart, financial planner at Finura, said savers should use up their Isa and pension allowances before considering riskier VCTs.

“The big advantage [of VCTs] is the upfront 30 per cent tax relief,” he said. “Where it becomes important is for higher earners who because of the pensions taper have their annual allowance reduced. By the time you’re earning £360,000, your allowance is reduced to £10,000.”

Investors must be willing to “tie up capital for five years” to benefit from tax breaks, noted Katherine Waller, co-founder of wealth manager Six Degrees, which advises wealthy individuals and entrepreneurs.

“By investing in a VCT, you’re effectively investing in a portfolio,” added Richard Stone, chief executive of the Association of Investment Companies. “You’re spreading that risk across a range of businesses and you hope that the handful of winners beats the handful of losses. But by the nature of it being high risk, some of those businesses fail.”

Waller tells her clients that VCTs “shouldn’t ever form more than 10 per cent of the value of their estate because of the illiquidity and the level of risk”.

Inflows to VCTs hit an all-time high in 2021, surpassing £1bn for two consecutive years before falling to £882mn in 2023.

“From 2010 onwards, we saw a huge uptick in the VCT market,” said Davies. “And then [in the 2023/24 tax year] the rules on pension allowances were tweaked slightly, so that higher earners could put more into their pensions than previously. As a result there was less money in VCTs.”

The drop in VCT funding followed a wider slowdown in private markets that was driven by an economic downturn and high interest rates.

“It feels like we’re turning a corner now,” said Davies.

There were 50 VCTs totalling £6.3bn in assets under management as of the end of October, according to the AIC.

Forty-three of these invested largely in unquoted companies and managed £5.6bn. The remainder invested in companies quoted on Aim, London’s junior stock exchange for small-cap stocks.