Venture Capital Trusts or ‘VCTs’ offer exposure to small, mainly privately-listed, entrepreneurial businesses – the ‘companies of tomorrow’, typically specialising in areas such as AI, autonomous driving, e-commerce, industrial automation, Deep Tech, Health Tech, etc.
They work similarly to traditional investment trusts – you buy shares in a listed company, which itself invests in a range of underlying businesses. The key difference is in the type of business that VCTs invest in – these must meet specific qualifying criteria in terms of asset size, age and number of employees.
To encourage investment into such businesses, VCTs carry significant tax benefits:
- 30% income tax relief on investment (as long as you have sufficient liability to offset and the investment is held for at least 5 years),
- Tax-free dividends (counterintuitively, the main source of return on underlying company exits), and
- Tax-free capital growth.
Note, these apply to new shares only, not those bought on the secondary market. Most VCT managers raise capital once a year, typically between November and April.
I wrote about VCTs in a previous blog – how they work along with the pros and cons – you can find this on my website here.
In this week’s blog, I focus on VCT recycling – how you can amplify long-term returns from VCT investing by switching positions every 5-6 years.
Disclaimer: ‘VCTs’ are high-risk products and not suitable for the majority of retail investors. They’re only appropriate for high net worth and/or sophisticated investors, and even then, only for a modest portion of investable assets (as a rule of thumb, I’d say no more than 20% of liquid assets).
The five-year flip
The mechanics and benefits of VCT recycling are best explained by way of an example.
In January 2020, Rose invested £30k into a new VCT. In doing so, she received 30% income tax relief - £9,000 was returned to her via a rebate upon the submission of her self-assessment tax return for the 2023/24 tax year.
- Fast-forward to January 2025. The VCT is still worth £30k and has paid total dividends to date of £7,500 (implies a 5% yield which is what most VCTs target),
- Rose is beyond the required 5-year holding period to avoid a clawback of the initial income tax relief and could therefore now consider ‘recycling’ her position.
- That is, she could sell her VCT – most VCT managers offer a buyback facility at a c.5-10% discount to the prevailing market value. Assuming the mid-point, she would realise proceeds of £27,750.
- She could then reinvest the money into a new VCT and in doing so would receive another round of 30% tax relief – a further £8,325, again returned to her by rebate (assuming she still has sufficient income tax liability to offset).
- Over a long timeframe, a strategy of repeat VCT investment and 5-year recycling can supercharge long-term returns. Albeit one must re-emphasise that this is a high risk sub-sector and returns can vary significantly between VCT managers.
The benefits of recycling are also illustrated in the chart below, which shows the gradual build in annual dividend income and tax relief, assuming Rose invests £30k a year in VCTs over 15 years. Notice the jump in tax relief every 5 years, due to the recycling effect:
- Without recycling, Rose would have received total income tax relief of £135k (£450k investment x 30% tax relief) over the 15-year period. With recycling, and factoring in a 7.5% buyback discount in each instance, she receives £257k (i.e. an extra £122k).
- By year 9, the combined dividend income and annual tax relief now more than offset the new VCT investment itself – in other words, the annual VCT investment has become ‘self-funding’.
- By year 15, the combined tax relief and tax-free dividend income amount to c. £45k a year and this would continue (on the assumptions stated) even without any new monies committed.
Please note, these figures are for illustrative purposes only and do not reflect actual investment returns, which can fluctuate and are not guaranteed.
Conclusion
VCT investment is not for the faint-hearted. It represents investment into portfolios of small, high-growth, entrepreneurial businesses, which inevitably carry additional risks. I would always place VCT investment below pension contribution and ISA saving, but for those who have ‘maxed out’ these wrappers, and are comfortable with the risks involved, VCT investment could be worth consideration.
Where this is the case, consistency is key – ideally committing a similar amount each year, and recycling positions every 5, to benefit from additional rounds of tax relief – this can supercharge long-term returns.
If you’d like to know more, please let me know.
When investing, your capital is at risk. The value of your investment (and any income from them) can go down as well as up, and you may get back less than you invested, particularly where investing for a short timeframe (we normally recommend a horizon of at least 5 years). Neither simulated nor actual past performance is a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
The Financial Conduct Authority does not regulate tax advice. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts and their value depends on the individual circumstances of each investor.
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only. Since I don’t know your specific situation, none of this information should be construed as tax or financial advice. It is not an offer to purchase or sell any particular asset and it does not contain all the information which an investor may require in order to make an investment decision. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles.
