VCTs: the good, the bad and the ugly
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The venture capital trust (VCT) industry is still haunted by the spectre of tax dodging.
There are often two ways to look at statistics, and VCT fundraising figures for the past tax year are a case in point. The tax-efficient investment vehicles, which are supposed to back growing companies, raised a total of £330 million in 2011/12, hailed by the Association of Investment Companies (AIC) as ‘the sixth highest amount since VCTs were first launched in 1995’.
While this is true, it is also a 10 per cent drop on what was raised in the previous year, and less than half of what VCTs brought in at their peak in 2005/6 (£779 million).
To be fair to the AIC, £300 million plus for investment in SMEs is not to be sneezed at. Or at least it wouldn’t be, if all that money went to genuine growth businesses.
VCTs are required to invest at least 70 per cent of their cash in qualifying companies: that is, those with assets of less than £15 million and fewer than 250 employees. It’s not 100 per cent, for obvious reasons: some money needs to be kept in cash or more liquid assets in case it is needed by existing portfolio companies, or further opportunities arise. That said, many successful VCTs manage to keep their percentage of qualifying investments well above the 70 per cent threshold.
This is where I come to the ‘good, bad and ugly’ bit. There are VCT managers which are well established, achieve good returns for their investors over and above the tax relief, and provide the catalyst for ambitious companies to grow. In other words, exactly what they are supposed to be doing. Albion Ventures, YFM and NVM spring to mind.
Others have made a genuine effort to invest in growth companies, but for whatever reason, delivered poor returns. Unfortunately, almost every AIM VCT falls into this category.
Then there are the ugly: those which obey the letter of the law – but only just – and leave the spirit of it way behind. Everyone in the industry knows this, and one day the Treasury will come down on these operators like a ton of Budget briefcases.
These pseudo VCTs have a number of tricks, but they’re summed up pretty simply as follows. They invest the minimum possible amount they can get away with under the VCT rules, in the safest businesses they can get away with (businesses that could get funding anyway). They do this for the minimum amount of time. Then the trust is wound up and the money returned to investors, with a paltry investment return and a generous 30 per cent tax relief courtesy of HMRC.
The winners from such schemes are the fund managers, and to a lesser extent the investors in these vehicles. The losers are businesses and the everyday taxpayer.
Recently, VCTs have discovered a new trick. You only get tax relief on new shares – which pretty much kills the secondary market for VCTs, incidentally. But what if you could sell your VCT shares back to the VCT manager at the end of the qualifying period, then immediately buy them back? You’d get the 30 per cent relief again, wouldn’t you?
Not every VCT manager offers this dodge, but too many do. Some call it an ‘enhanced buyback facility’, others a ‘share realisation and reinvestment programme’. Whatever the name, the effect of it is to allow holders of VCT shares to recycle their money and receive fresh tax relief, rather than commit new funds to the kind of businesses the government is relying on to drive economic growth.
I wonder whether this could be one reason why the amount invested in VCTs is falling again.