As we draw towards the end of another tax year, investors naturally turn their attention to making use of any tax efficient allowances before they expire.
This is only natural – after all, an investor’s return should be measured on a net basis, ie after deduction of all dues including taxes. For many, this portfolio spring cleaning entails topping up ISAs and pensions but this year has seen super-normal interest in Venture Capital Trusts (VCTs), vehicles that typically invest in smaller, riskier businesses (both private and quoted on AIM) but which carry substantial potential tax benefits.
Many of the subscription offers launched by the raft of VCT fund managers this year have proved so popular that they have been closed early. The Northern range of VCTs, for example, proved so popular they remained open for less than 48 hours.
Stories of punters so desperate for the tax relief driving hundreds of miles to get their applications in before the deadline is reminiscent of the government IPOs of the 1980s and tech IPO boom of the 1990s.
This super-normal demand is being driven to a large degree by the tapering of tax relief on pension contributions for very high earners. As of last April, earners with income of £150,000 or more face a taper to their annual pension contribution allowance from the standard £40,000 down to £10,000 on a salary of £210,000.
Effectively, someone earning more than this is restricted to contributing £10,000 per annum to their pension as there is no tax benefit for any amount above that. This is driving the search for other ways to deploy capital in a tax efficient manner and perhaps explains the rationale of quoted pension trustee Mattioli Woods making a strategic investment in VCT manager Amati Global Investors last month.
At the same time as demand for VCTs – and their counterparts, Enterprise Initiative Schemes (EIS) – is increasing, the universe of investable companies that qualify for such reliefs is shrinking.
In 2015, the rules were tightened with perhaps the most restrictive being a seven year limit on companies “after their first commercial sale took place”. There are certain exceptions, for example for knowledge intensive businesses, but by and large companies older than seven years are not usually eligible for EIS and VCT investment. In addition, investment managers who have raised VCT funds have a fixed length of time to deploy the capital or they face the embarrassment of having to return the cash to investors. A situation
potentially exists, therefore, where VCTs can become forced buyers and this has potential implications for valuations of the most sought after assets.
Flipping this around suggests that the environment for those companies that do qualify for EIS and VCT investment is very favourable, both in the private and public (AIM) markets.
Whilst investors will expect to do substantial due diligence before committing to what is by nature a long term and relatively illiquid asset, even on AIM, a growing pool of money with a finite lifespan to be deployed can shift the balance somewhat.
One such Yorkshire company, which raised new capital on AIM through a tax qualifying issue, is Rotherham-based Fishing Republic, where the shares are now trading at around three times their 2015 float price.
So, whilst spring is the time for investors to get their personal affairs in order, it may also be time for the bosses of Yorkshire’s fledgling businesses to have a good look at whether EIS and VCT investment can help them grow into the stars of tomorrow.
Whilst VCTs are inherently at the riskier end of the spectrum, tax benefits can be substantial. Provided the VCTs are bought at launch and not on the secondary market, these can include: no income tax payable on dividends received; no capital gains tax payable upon realisation; and income tax relief of up to 30 per cent on the initial investment (subject to a minimum holding period of five years).
This latter benefit is what makes VCTs so attractive to those high earners who are limited to putting £10,000 a year tax free into a pension pot.
Finally, as last week’s Budget showed, tax rules can be changed by the Chancellor at will and professional advice is essential.