Under the current rules for venture capital trusts (VCTs), income tax relief at a rate of 30% is given on the purchase of newly issued VCT shares. If the shares are disposed of within five years, the tax relief is clawed back. The five year period – it was once three years – does not mean that VCTs should be regarded as five year investments, although some schemes have been promoted on the basis that shortly after five years the underlying investments will be sold and the proceeds returned to shareholders.
One variation on this theme has been the ‘enhanced buy back’ arrangement. This typically involved the VCT investor who has reached their five year holding period:
- Selling their VCT shares back to the provider at or very close to their underlying net asset value (generally about 10% higher than the quoted share price, but possibly 20% higher);
- Immediately applying the proceeds to buy shares in the same VCT at 2%-3% more than the sale price; and
- Claiming 30% income tax relief on the amount (re)invested.
The process means the investor ends up with about 2%-3% fewer shares, but that reduction is a small price to pay for the second round of tax relief. The VCT manager makes a small turn and locks in the investor (hence usually high management fees) for another half decade.
The Chancellor signalled in this year’s Budget Red Book that he was not happy with such tax relief recycling and the Treasury has now issued a consultation document about closing down the perceived loophole. Although any change is scheduled for April, the Treasury warns that it will take pre-emptive action if necessary. The implication is that any rush to recycle VCT investment made at the end of 2008/09 or earlier will be blocked.