With the tax burden at a record high, affluent investors who have maxed out their ISAs and pensions might be exploring alternative ways to reduce their tax obligations.
One popular avenue is investing in startups through a venture capital trust (VCT). These investments can bolster small and medium-sized enterprises in the UK. Typically, VCTs purchase shares in funds that invest in a mix of 40 to 80 privately-held, fast-growing companies.
Fund managers select these firms, which can be anything from high-tech innovators to consumer brands. Some VCTs focus exclusively on companies listed on the Alternative Investment Market (AIM).
Successful VCT investments have included names like the real estate portal Zoopla, women’s fashion retailer ME+EM, data platform Quantexa, and an investment platform.
Tax Benefits
The main draw of VCTs is the tax perks. For every £1 invested, you can receive up to 30p of tax relief upfront. However, just last week, the Chancellor announced a reduction to 20p per pound starting in April. All capital gains and dividends remain tax-free, and you can invest up to £200,000 in VCTs annually. The tax relief cap is £60,000, but you can’t claim more than you owe.
Investments must be held for at least five years to qualify for the tax advantage. If sold before five years are up, you have to repay the tax relief. Typically, taxpayers claim this relief on their self-assessment returns, which can either lower their tax bill or yield a refund if tax has already been paid.
Most VCTs aim to deliver dividends of about 5-7% annually, with some even offering higher dividends, and there’s no obligation to declare tax-free dividends.
After a drop in investment, there’s been a noticeable increase in funding for these types of opportunities. In the 2024-25 tax year, £895 million was invested in VCTs, marking the third-highest annual figure in their two-decade history. The peak was in 2021-22 with £1.11 billion, which fell back to £882 million in 2023-24.
Nick Hyett from investment management firm Wealth Club noted, “While the 30% upfront income tax relief has always drawn attention, the dividend tax exemption is often overlooked. With dividend taxes increasing by 2 percentage points in April, it becomes even more appealing.”
He added, “Freezing the tax base forces more people into higher tax brackets, leading to increased rates and the loss of various deductions. Tax-free dividends from VCTs enhance your income without increasing your taxable income. Plus, for those who don’t need the cash flow, these dividends can be reinvested into new VCT shares, which may provide additional tax relief.”
Hyett also mentioned that changes coming in the Budget will reduce tax relief on investment income to 20% starting in April. Even so, the more favorable relief might prompt a rush for this tax year. Given the limited number of VCTs available, this could lead to a ‘buy now while stocks last’ situation for the best-performing managers.
On a brighter note, the Chancellor also revealed plans to allow VCTs to invest in more mature businesses moving forward.
Revenue from VCTs outpaces that of firms on major markets, offering robust long-term returns for investors.
A study by Wealth Club highlighted that 36.8% of VCT’s net assets are allocated to companies experiencing annual revenue growth of 25% or more, while only 2.1% of all FTSE companies have achieved similar growth.
Risk
Of course, there are risks involved. VCTs typically invest in early-stage businesses that have a higher chance of failure and can be more challenging to sell. Although they’ve seen weak performance recently, the long-term outlook is still strong.
According to Wealth Club’s analysis, VCTs averaged a decline of 2.4% over three years but managed to return 14% over five years and 47% over ten, factoring in reinvested dividends.
Hyett pointed out, “Despite exposure to high-growth firms, the underlying valuations of these private companies have dropped significantly over the last five years. This means that while the VCT sector is currently underperforming, it also offers new investors a chance to engage with some of the UK’s most promising startups.”
Keep in mind that fees for VCTs can be relatively high compared to other funds. Initial commissions can be as much as 5.5%, though many brokers offer discounts. While the dividend targets are enticing, they aren’t guaranteed, and investments in VCT schemes lack the protection of the Financial Services Compensation Scheme.
How to Choose a VCT
VCTs generally raise funds by issuing new shares from September to January, and popular offers can sell out quickly, sometimes within a day.
Diana French from investment firm Triple Point advised that “there are many different types of VCTs, each with their own focus, so it’s essential to do your research on what you’re investing in.” Some emphasize early-stage businesses, while others may invest in more established firms.
Checking the company’s dividend and share buyback policies is crucial. “If you expect regular dividends, it’s valuable to know the company’s targets. Some aim for high regular dividends of up to 7% of NAV, while others have more variable dividends,” Hyett stated.
Understanding that there’s no secondary market for shares is also essential; when you want to access funds after five years, you’ll sell your shares back to the VCT. Most companies endeavor to buy back stock at a 5% discount to NAV, though not all set a target, which could significantly affect overall returns,” Hyett concluded.
