VENTURE CAPITAL TRUSTS (VCT)

ENTERPRISE INVESTMENT SCHEMES (EIS)

These tax efficient investments are for investors who are able to take and can afford to take risk, being investments in new and small businesses. Because risks are high however, there are some attractive tax reliefs.

VCT

• Income tax relief of 30% up to a maximum personal investment of £200,000 as long as you hold the investment for 5 years
• Tax free dividends
• No capital gains tax on sale

These are investments into an approved investment trust company which must be limited on a main market, with the trust itself investing in unlisted small trading companies, subject to various restrictions.

EIS

• Income tax relief of 30% (up to £1m) as long as you hold the investment for 3 years
• Up to 100% can be backdated to previous tax year
• Opportunities to defer capital gains tax
• Inheritance Tax Business Property Relief after 2 years

These are investments in small trading companies which may be listed on AIM, but not a main market.

Despite the attraction of the tax reliefs, both of the above must be judged as high risk and long term. You can lose some or all of your investment - bear in mind these are investments in small, often start-up companies. There is often no liquidity - ie it may be very difficult to realise (sell) your investment - there is often no trading market and you may be able to exit only on takeover or liquidation of the company. Great care is therefore required before considering such investments and you should read carefully and fully any prospectus provided.

VENTURE CAPITAL TRUSTS

   What Are Venture Capital Trusts?

    Venture Capital Trusts (VCTs) form an important part of the

   government's  strategy to help direct money into smaller businesses to

   finance that growth. In brief, they are pooled investments in

   companies whose shares and securities are not listed on the main

   stock exchange. As such companies tend to be higher risk than large

   'blue chips', and because of this, and to attract investment, the

   Government offers tax breaks as an incentive. 

   Once launched VCTs are listed on the London Stock Exchange, which

   lays down rigorous standards. Money raised from individual investors is

   pooled by the VCT to acquire a number of different investments. In

   order to qualify for tax relief, the VCT manager must invest at least 70%

   of new proceeds in 'qualifying holdings' (that is, shares or securities that

   meet the conditions set by the VCT rules) within three years. The

   underlying investments tend to consist of shares or securities

   (including loans of five years or more) in unquoted companies and new

    shares that will be issued on the Alternative Investment Market (AIM)

   and ISDX Markets.

   Qualifying companies within a VCT must:-

·         Be UK trading companies

·        Have 'gross assets' of less than £15 million prior to

       investment and less than £16 million immediately after

        investment

·         Have fewer than 250 employees

·        Have raised no more than £5 million from venture

       capital schemes over the previous year

·         Not have their shares must not be listed on a

       'recognised stock exchange'.

The balance of 'non-qualifying' investments are typically

invested in cash, bonds, listed shares or funds, depending on the

approach of the VCT.

What Are The Tax Reliefs?

The main tax reliefs available on investments in qualifying VCTs

are:

* 30% tax credit on up to £200,000 invested in a tax year.

This is available on new issues of VCT shares (which must then be

held for at least five years). You must have paid the amount of tax

that is being rebated, whether that is lower, basic, higher or

additional rate tax. If shares are sold within the first five years you

lose the tax rebate.

* No Income Tax is payable on any dividends received –

no need to be declared on tax returns. This is available on purchases

of new and existing shares. There is a notional tax credit attached but

this cannot be reclaimed. The tax relief is particularly attractive for

higher rate tax payers.

* No Capital Gains Tax liability if the VCT shares are

subsequently sold at a profit. However losses on the VCT

shares cannot be offset against future gains if the VCT shares are

sold at a loss.

It should be noted that these tax reliefs are generous because

of the high risk nature of the investment. You should only

consider such investments if you are an experienced

investor. You should never let the "tax tail wag the investment

dog".

 Types of VCT

There are three basic types of VCTs: Generalist, AIM and

'Limited Life' VCTs.

Generalist VCTs

These focus on private companies and tend to keep the

balance of their money (the 30% which is 'non-qualifying money')

in cash or near-cash alternatives.

As there is little liquidity in the shares of these businesses, the

VCT manager will play an active role in supporting the company,

for example by having directors on their boards.

This is really the realm of "private equity" and represents

traditional venture capital activities, accounting for more than

half of all VCT investment. Private equity investment requires

many different processes compared with buying quoted shares

- sourcing deals, managing the investment and achieving an exit.

Whereas any fund manager can buy shares in a listed company, in

the private equity world companies get to choose who they want as

their investors, so the managers with the best reputations often get

access to the most deal flow.

Since there is no immediate ability to sell the shares (ie they are

illiquid), the VCT manager needs to be extremely confident in

the purchase decision. This requires extensive investigation

('due diligence') which can take several months. Once the investment

has been made, the subsequent monitoring of the company can

be very time consuming, hence it's not uncommon for groups to

make only three or four investments a year and for the managers to

seek board representation at companies they back.

Most private equity returns tend to come in the later years of the

underlying companies' development, so it's important to hold for

the long term. Success rates also vary widely, so investors should

seek as much diversification as possible.

Some VCTs concentrate on a specific sector, such as

clean-technology.  

AIM VCTs

AIM is a junior market for UK smaller companies.

Investing in AIM companies should give VCT managers greater

flexibility, and AIM VCTs focus on companies issuing shares or on

the Alternative Investment Market (AIM).

While AIM shares can be illiquid, it is possible to trade them

once issued, so the management skills on these VCTs are

more akin to a mainstream smaller companies funds. Research

covering these companies is more widely available than for private

equity; there is a daily share price and the ability (at least in

theory) to sell the shares. 

However, the AIM admission rules do not require any

minimum track record, so even start-up companies can join.

Risk can therefore be on par with private equity or even

greater in some instances

 Limited Life or Planned Exit VCTs

These launch with an intention to wind-up after five years and

return capital to investors. Given this narrower time horizon

than for other VCTs, their focus will be to preserve capital by

holding lower risk non-qualifying investments such as cash and

bonds and by pursuing a more conservative approach to qualifying

investments.

For example, they may choose to invest in businesses where they

can secure loans made against a tangible asset, such as a

freehold property. Although the obvious asset-backed 

investments, such as hotels and property development, have been

specifically excluded from VCTs, there are still several sectors that

can offer the investor the benefit of a fixed-asset security, such as

public houses, garden centres or schools or businesses in industries

that receive government subsidies.

Asset-backed VCTs should be able to sustain a more

consistent level of dividend and are commonly used in limited-life

VCTs.

A large proportion of the overall returns from such VCTs is

likely to come from the tax relief.

The Pros and Cons Of VCTs

PROS

The main tax reliefs available on investments in qualifying VCTs

are:

* 30% tax credit on up to £200,000 invested in a tax year. This

is available on new issues of VCT shares (which must then be held

for at least five years). You must have paid the amount of tax

that is being rebated, whether that is lower, basic, higher or

additional rate tax. If shares are sold within the first five years you

lose the tax rebate.

* No Income Tax is payable on any dividends received – no

need to be declared on tax returns. This is available on purchases

of new and existing shares. There is a notional tax credit attached but

this cannot be reclaimed. The tax relief is particularly attractive for

higher rate tax payers.

* No Capital Gains Tax liability if the VCT shares are

subsequently sold at a profit. However losses on the VCT

shares cannot be offset against future gains if the VCT shares are 

sold at a loss.

VCTs do enable more diversification away from investment

funds and shares, although with much higher risk.

CONS

Higher charges - VCTs are more expensive than most

other types of investment. The initial charge is typically 5% and

the ongoing annual costs are typically 2.5-3.5%, often with 

performance fees.

Greater Risk. Risk varies between different VCTs, usually

depending on their investment policy. Most of a VCT's assets will be

invested in small UK trading companies which do not have to

be start-up ventures but you should regard the overall risk level as

being much higher than that of a unit trust investing in 'blue chip'

companies.

Poor Liquidity. Although VCT shares are listed on the

London Stock Exchange, the volume of shares traded tends to

be low. The spread between buying and selling prices can be

wide and VCTs almost always trade at a discount to their

underlying net asset value. You may have difficulty in realising

your shares at the true value. Discounts vary considerably from

trust to trust.

OTHER RISKS ASSOCIATED WITH VCTs

·    Prospective investors should carefully review the risks

within each specific VCT offering.

·  The value of shares in the VCT and the income from them

can fluctuate up or down and investors may not receive

back the full amount invested.

·    Past performance is not a guide to future performance.

·   There is no guarantee that the market price of shares in

the VCTs will reflect the underlying net asset values of the

companies.

·  An investment in VCT shares is only suitable for

investors who are capable of evaluating the merits and

risks of such investment and who have sufficient resources to be

able to bear any losses which may arise (which may be equal

to the whole amount invested).

·   The investments should be considered as long-term

investments.

· VCTs generally invest in smaller unquoted companies

and this approach carries particular risks.

· It is of course the intention that each company within

a VCT will continue to be managed so as to qualify as a VCT.

If however a company fails to meet the qualifying requirements

for a VCT, this could result in: (i) investors in that company being

required to repay the 30% income tax relief received on

subscription for the shares in that company; (ii) loss of income

tax relief on dividends paid (or subsequently payable) by that

company; (iii) a potential liability to tax on capital gains on a

disposal of shares in that company; and (iv) loss of tax relief

previously obtained in relation to corporation tax on capital

gains made by that Company.

·  Failure to meet the qualifying requirements could, in

addition, result in a loss of the listing of the shares.

·  The tax reliefs referred to are those currently available and

their value depends on the individual circumstances of investors.

· The definition of a VCT qualifying investment may

change, and the conditions relating to the maintenance of

that qualifying status may also be subject to alteration, which

could impact on the level of each company's qualifying holdings

for VCT purposes. EU legislation may change and such

changes may be retrospective.

· The sale of shares within 5 years of their subscription will

result in some or all of the 30% income tax relief available upon

acquisition of those shares becoming repayable.

· Any realised losses on the disposal of shares cannot be used

to create an allowable loss for capital gains tax purposes.

· No guarantee is given or implied that the investment

objectives or the realisation strategies set by the

companies will be achieved.

· Furthermore, a VCTs ability to obtain maximum value

from their investments (for example, through sale) may be

limited by the requirements imposed in order to maintain the

VCT status of that Company (such as the obligation to have at

least 70% by value of its investments in qualifying investments).

·  VCT investments will be in companies whose securities are

not publicly traded or freely marketable and may, therefore,

be difficult to realise and more volatile than the securities of

larger, longer established businesses.

Who Should Consider Investing In VCTs?

 VCTs are not an appropriate investment for everyone.

They should only be considered by experienced investors who

are liable to higher rates of Income Tax, are willing and able

to hold their investment over the longer term, are comfortable with

taking on a  high level of risk, and are able to sustain losses should

these occur.

Before investing in a VCT, you should therefore carefully read

each VCT prospectus, especially the section on risk factors,

particularly important if you are considering investing in a VCT for

the first time.

If you do decide to invest, we strongly recommend that you

make sure that your total commitment to VCTs is modest in

relation to your total investment portfolio.

If in doubt, do not invest.

What Services Do We Offer?

We shall consider the suitability of VCTs for your

circumstances, or on the attractions or otherwise of particular

VCTs.

You may ask that we provide details of VCTs being offered

currently and we shall do so.

The decision as to whether to invest or not is your own, after

discussion with ourselves.

Our view is that such investments are to be considered for

professional investors, or individuals with significant

understanding of investments who can afford to lose part

or all of their investment. 

Nothing in this guide should be regarded as being personalised advice.

Levels and bases of taxation can change and the availability of

tax reliefs will depend upon individual circumstances. The value

of investments and the income from them can fall as well as rise. 

It should be noted that, given the attractive tax breaks, these

investments must be judged as high risk to very high risk, liquidity

may be low or non-existent, investments do not have a finite

investment period, you can lose all of your investment (remember,

these are investments largely in small start-up companies),

there are no guarantees.