High Hopes for New Venture Capital Trust Tax Rules

by Robert Lee, Tax-News.com, London

03 February 2004

Changes in the UK tax rules for venture capital trusts, which Chancellor Gordon Brown hopes will revive the market and increase the amount of capital available to invest in small firms and start-ups, will go into effect from April 6 this year.

The government’s actions are in response to the sharp decline in the amount of funds raised by venture capital trusts in the wake of the bear market, which saw the VCT formations shrink from £450 million at their height to just £45 million.

Under the government’s proposals, the investment limit on trusts will be raised from £100,000 to £200,000 whilst income tax relief is increased to 40%, of which 20% will be paid directly into the trust rather than to investors. This will mean that for every £1 invested in a fund, investors will receive 20 pence in income tax relief, plus a further 20 pence will be placed into the fund by the Treasury.

What investors have gained in income tax breaks, they have lost in the removal of the ability to defer capital gains tax by investing in venture capital trusts, which the Treasury hopes will even out the “cyclicality of fundraising”. However, industry participants suggest the income tax breaks will more than compensate.

Furthermore, the twenty pence income tax relief is only a temporary measure aimed at stabilising the venture capital market, and will be removed after two years. Beyond this, the Treasury suggests offsetting the removal of capital gains relief by an increase of equivalent value in income tax relief.

There are also question marks remaining as to whether the new rules benefit only higher rate taxpayers. Nevertheless, reports indicate that the venture capital industry is broadly supportive of the new measures, despite these uncertainties.

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