The amount raised by Venture Capital Trusts (VCTs) has gone up by 28% year-on-year, according to new figures released by HMRC for the 2016/17 tax year.
The surge in interest has been driven by more wealthy investors looking at VCTs as tax-efficient alternatives to pensions, which are subject to lower annual allowances and lifetime limits than in the past.
However, the number of VCTs raising funds has dropped to 38 in 2016/17, compared with 45 in 2015/16.
VCTs are quoted private equity funds whose shares trade on the London stock market. They invest in unlisted small and start-up companies. One VCT typically invests in around 20 such businesses, which are chosen by the VCT manager. Such companies are considered higher risk than more established, listed companies.
Investors are attracted to new issues of VCT shares because of the income tax relief they provide, at a time when pension tax relief has been curtailed.
VCTs offer a range of tax breaks, including 30% income tax relief on new shares if they are held for a minimum of five years, tax-free dividend payments and exemption from capital gains tax.
Therefore, VCTs are sophisticated, long-term investments only suitable for inclusion in significant portfolios.
‘Since they were launched in 1995, VCTs have raised over £7 billion, providing significant capital for investment into this vital sector of the economy and playing a critical role in helping to develop the next generation of UK businesses,’ says Paul Latham, managing director at Octopus Investments.
Alex Davies, CEO and founder of Wealth Club, says: "Investors are unable to put large sums in pensions, so they’ve turned to VCTs as a tax-efficient alternative.
"Demand for VCTs was huge last year, with some offers closing within days due to limited capacity. This year looks to be an even bigger year for VCTs."
Mark Dampier, head of investment research at Hargreaves Lansdown, echoes these views. He says it is "hardly surprising given tougher annual allowances and lifetime limits on pensions that more investors are looking at VCTs".
But he cautions that the impending November budget might again change the rules of what VCTs can invest in and possibly change the available tax relief.
He adds: "Investors buying VCTs today should recognise that the last rule changes on investment have made many VCTs more risky than they once were. As ever don’t make tax relief the sole reason for investing."
This article first appeared on our sister website Money Observer.