Tax-savvy investors who had previously been able to enjoy 30% tax breaks on investments in venture capital trusts (VCTs) will get a less generous 20% this year after changes announced in last year’s Budget came into effect from 6 April.
The remainder of the rules are the same: the tax break applies immediately for the financial year in which the investment is made but investors must hold the shares for a minimum of five years or pay HMRC back the tax.
Towards the end of last year there was outrage, with Jason Hollands, managing director of Evelyn Partners, calling it a “retrograde move” that will “decimate fundraising”.
VCTs invest in young UK businesses and have been viewed by governments as a way to encourage people to back young British businesses.
The tax relief was a way to incentivise people to do this, with the added benefit that any dividends earned are free from tax and there is no capital gains tax to pay when the shares are sold.
However, there is a rather large part of the equation that the industry has failed to make good on: returns. After all, what good is it to say there are no capital gains to pay if an investment makes a loss anyway?
Over the past five years, VCT performance has been disappointing at best. On average, funds in the IT VCT Generalist sector have made just 5.9%, while those in the IT VCT AIM Quoted peer group have lost investors a whopping 36.6%.
These figures can be skewed by the relatively poor performance of the largest constituents, so I have also pulled out some different numbers.
Of the 41 funds (across both sectors) with a five-year track record, 17 (or 41.4%) have lost investors money, with a further five making single-digit returns.
But often overlooked is the opportunity cost associated with investing in VCTs. One obvious comparator is the FTSE All Share – an index of the main UK market. While VCTs are not designed to mirror listed markets, the gap is stark.
The index has made 69.3%, a return that no VCT has matched. The figures look even worse when compared against better-performing markets such as the US.
When including the 30% tax relief, the bar is admittedly much lower. Investors are effectively paying 70p on the pound when they invest (with the 30% relief), meaning trusts only need to return 18% to match the 69% made by the FTSE All Share. Even with this lower bar, only 15 trusts (around a third of the total) have achieved this.
These funds are supposed to invest in young companies that have the potential for strong growth, yet the returns have not been able to justify investing – in many cases even with the 30% tax relief.
Yes, a drop to 20% will reduce the appeal of VCTs. From a business perspective it will limit the flow of money going to upstart UK companies that desperately need the funding.
But it also may save investors from being locked into a poor-performing fund for a minimum of five years.
So while fund managers may bemoan the drop in the tax relief and the relative lack of appeal they will offer to investors looking to avoid their money ending up in the hands of the tax man, I would argue they should focus on producing better returns in the first place.
Imagine if investors could get tax relief and good returns. Wouldn’t that be something?