HMRC should stop changing the investment rules because managers usually find a way around them
In the Budget the Government announced a consultation and evidence-gathering exercise to understand the impact of the recent VCT reforms.
The consultation includes potential changes to legislation and asks if the list of excluded activities is appropriate. In light of this, here are my thoughts on how and why VCTs have prospered and where they go
VCTs have undergone frequent alterations over the years, including types and rates of tax relief, minimum holding periods, investment limits and changes to how a VCT invests. Thankfully the past few years have been quite stable, with tax rates and holding periods unchanged.
The change in 2006 from 40 to 30 per cent income tax relief caused few problems because it was still generous and shortly afterwards the annual limit changed from £100,000 to £200,000.
Managers were more exercised about the stricter changes to what VCTs could invest in – mainly on equity versus debt instruments.
Since 2010, the Government has increased flexibility to widen the number of potential investee companies for VCT managers. The limits now allow companies with up to 250 employees and up to £15m in gross assets to qualify.
The level of tax-advantaged investment that a qualifying company can receive has also increased, to £5m a year. For VCT managers investing in growth companies in need of capital, these are sufficiently broad limits and do not need further alteration.
What would I do with VCTs now to sustain their popularity? When interest rates inevitably rise, VCT sales will falter. Ignoring the possibility of increased tax relief, which in the current economic climate will not happen, I would first raise the annual investment limit to £500,000.
VCTs have been shown to provide economic benefit so if the Government wants more money invested in small and growing companies, simply increase the annual limits.
This is an easy win but could managers cope with an influx of new money? Now that pension contributions are in effect limited to £40,000 a year, wealthier clients need other options so it would be a welcome move.
My next change would be to stop making changes – that is, to the investment rules. Whatever rules HM Revenue & Customs devises to limit or prescribe what VCTs can do, clever managers usually think of ways around them.
HMRC should accept this and have a simple list of do’s and don’ts while cracking down on transgressors who go against the spirit of the VCT legislation by targeting low-risk low-return investments that do little to help the wider economy.
To encourage new entrants to the market, I would reverse the recently instigated rule that new VCTs must wait three years before paying dividends from the share premium account. This means new entrants find it difficult to compete with existing VCTs because they cannot pay dividends of any significance in the early years.
Many investors value the stream of tax-free income from year one and gravitate to VCTs that are fully invested. With dividends in full flow, HMRC needs to level the playing field here. If this rule cannot be changed, how about an increased up-front tax rebate for new VCTs? It works for EISs and SEISs.
To encourage investors to remain invested in VCTs for the long term, why not provide inheritance tax relief for those who die and have held the shares for more than two years? This mirrors the business property relief rules and would be available if investors had a direct holding in the underlying investments.
Finally, a controversial thought. Now that shares listed on the Alternative Investment Market can be purchased in an Isa, are Aim VCTs really necessary?
In light of the announced consultation on VCTs, Ben Yearsley puts forward proposals that would dramatically increase the annual limit on VCTs and pleads for a period of stability on the investment rules.