Investors flock to funds with 30% income tax break

Venture capital trusts (VCTs) raised £542 million - the second highest amount ever raised - in the 2016/17 tax year.

According to the Association of Investment Companies (AIC), who crunched the numbers, it's the largest amount raised since 2005/06 (£779 million), when income tax relief was increased from 20% to 40%.

The fundraising total for 2016/17 is 18% more than 2015/16's (£458 million) - the sharpest increase in fundraising in one year since 2003/04-2004/05.

Demand for VCT investment saw capacity in the market diminish very quickly towards the end of the 2016/17 tax year, with just £66 million of shares left available by 10 March.

The sector has shown strong growth over the last decade, with the average VCT fund up 82% in terms of share price total returns between the start of 2006 and end of 2016.

VCTs offer an alternative to dwindling tax-free pension allowances

VCTs have grown in popularity in recent years, due to a reduction in both the lifetime allowance and annual allowance for pension funds. Since 2010/11, the annual tax-free allowance for pensions has been cut from £255,000 to £40,000, meaning that high-earning investors have had to find new investment avenues.

And, with the £40,000 allowance potentially under threat of further cuts to come in the Autumn Budget later this year, VCTs, may continue to improve on recent fundraising successes.

Ian Sayers, chief executive of the AIC, said: "These figures are a testament to the ongoing demand for VCTs by investors, boosted by the pensions restrictions and attractions of a tax-free yield, and the ability of managers to adapt to the new investment rules."

VCTs are high-risk investments, but investors are compensated by a number of generous tax incentives including 30% income tax relief (although this must be repaid if the shares are not held for five years) and tax-free dividend payments.

Where should venture capital trust investors look in 2017

The growing interest in VCTs will benefit the wider economy too, according to Sayers.

"This is great news for UK smaller companies who are accessing the finance and expertise they need to grow [as] VCTs have an excellent track record of providing scale-up capital to smaller companies, creating growth, jobs and innovation.

"The growth of smaller companies is vital for the UK's economic success and some of the businesses VCTs support develop into household names," he added.

VCT fundraising figures

This article was originally published in our sister magazine Money Observer. Click here to subscribe.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.