Venture Capital Trusts (VCT) - A Business Sale Report Guide

Despite the recent tax rises there are still ways to invest in businesses in a tax efficient manner. Investment in small companies is now seen as a vital way to fund the private sector recovery and in many cases can provide the necessary risk capital that banks have been unwilling to provide. For investors they can invest through a Venture Capital Trust or VCT, and for companies looking for funding they need to meet certain conditions that allow a VCT to invest in them. This article will look at these requirements later.

A VCT is a company, broadly similar to an investment trust, which has been approved by HMRC and which subscribes for shares in, or lends money to, small unquoted companies. Under the VCT scheme, VCTs and their investors enjoy certain tax reliefs (see below).

The VCT scheme is designed to encourage investment in small unquoted companies. Individuals invest by holding shares in a VCT. The VCT invests in a spread of small unquoted companies, enabling investors to spread their risk, just as they do by holding shares in an ordinary investment trust company.

An approved VCT has a number of tax advantages:
Income Tax reliefs:

Exemption from Income Tax on dividends from ordinary shares in VCTs ('dividend relief').
'Income Tax relief' at the rate of 30 per cent of the amount subscribed for shares issued in the tax year 2006-07 and onwards (for subscriptions for shares issued in previous tax years the rate is 40 per cent). The shares must be new ordinary shares and must not carry any preferential rights or rights of redemption at any time in the period of five years beginning with their date of issue. You can get this relief for the tax year in which these 'eligible shares' were issued, provided that you subscribed for the shares on your own behalf, the shares were issued to you, and you hold them for at least five years.

• The Income Tax relief at 30 per cent is available to be set against any Income Tax liability that is due, whether at the lower, basic or higher rate.
Capital Gains Tax reliefs

There is a Capital Gains Tax relief:
• you may not have to pay Capital Gains Tax on any gain you make when you dispose of your VCT shares. (This is called disposal relief).
You can get two of the reliefs, dividend relief and Capital Gains Tax exemption, for both newly issued shares and second-hand shares acquired, for example, through the Stock Exchange. But Income Tax relief can be claimed only if you subscribe for new shares.
You can get Income Tax relief for a tax year if shares in VCTs for which you subscribed up to a maximum of £200,000 are issued to you in the year. A tax year begins on 6 April in one year and ends on the following 5 April.

How do I get my company to qualify?
If a company issues any of its shares or securities to a VCT, it must meet certain conditions if those shares or securities are to form part of the VCT's qualifying holdings. These conditions concern both the type of company and the size and mix of investment. There are, for example, requirements as to the company's
• unquoted status
• trading activities
• gross assets
• independence
• subsidiaries

Unquoted status
The company must be unquoted for VCT purposes. This means that none of its shares, stocks, debentures or other securities can be listed on a recognised stock exchange.
Companies whose shares etc. are dealt in solely on the Alternative Investment Market (AIM) of the London Stock Exchange or on two of the Plus Markets are unquoted companies. Those trading on Plus Traded and Plus Quoted will be regarded as unquoted, those trading on Plus Listed will not, as this was designated a recognised stock exchange in July 2007. Shares or securities in a company which ceases to be unquoted can continue to be treated as being comprised in the VCT's qualifying holdings for the following five years.

Trading activities
The company must exist for the purpose of carrying on a 'qualifying trade' or be the parent company of a trading group whose business as a whole meets the scheme's rules. The funds received from the VCT must be used for the purpose of a qualifying trade carried on wholly or mainly in the UK.
Most trades qualify, provided that they are conducted on a commercial basis with a view to making profits. A trade will not qualify if one or more excluded activities together make up a 'substantial part' of that trade. This will depend on the relevant facts and circumstances, but we generally consider that they do where they amount to more than 20 per cent of the trade.

The main excluded activities are:
• dealing in land, financial instruments, or in goods other than in an ordinary trade of retail or wholesale distribution
• financial activities, property development, or providing legal or accountancy services
• leasing or letting assets on hire, except in the case of certain ship-chartering activities
• receiving royalties or licence fees, except where these arise from an intangible asset such as a patent or know-how, where most of it has been created by the company (or one of its subsidiaries)
• farming, market gardening, or forestry
• operating or managing hotels, guest houses, hostels, or nursing or residential care homes
• providing services to another company in certain circumstances where the other company's trade consists to a substantial extent in excluded activities
• shipbuilding, producing coal or steel
Gross assets
For investment of funds raised from 6 April 2006, the value of the company’s gross assets must not exceed:
• £7 million (previously £15 million) immediately before the VCT makes its investment, and
• £8 million (previously £16 million) immediately afterwards.
If the company is a member of a group, the limits apply to the gross assets of the group, taken as a whole. This is known as the 'gross assets' rule and our interpretation of it is given in Statement of Practice SP2/06
Independence

The company must not be controlled by:
• another company, or
• another company and a person connected with that company.
Nor must there be any arrangements for such control. For this purpose a company controls another company if it directly or indirectly possesses, or is entitled to acquire:
• more than 50 per cent of the company's share capital or issued share capital, or
• more than 50 per cent of the voting power in the company, or
• enough of the company's issued share capital to entitle it to more than 50 per cent of the company's income, if it were all distributed to the company's participators, or
• more than 50 per cent of the assets of the company that are available for distribution to the company's participators on its winding-up.
For this purpose all loans (except loans convertible into shares) and fixed-rate preference shares that do not carry voting rights are ignored.

Subsidiaries
A company in which a VCT invests may have subsidiaries providing that they meet certain conditions, which are outlined below.
In the case of each subsidiary, the company invested in must directly or indirectly own more than 50 per cent of the ordinary share capital of the subsidiary and the subsidiary must not be controlled by any person other than the company invested in or another of its subsidiaries. Additionally, any subsidiary whose business consists wholly or mainly of holding or managing land or property deriving its value from land must be at least 90 per cent owned directly by the company invested in. If the money invested in the company by the VCT is to be used by a subsidiary, then that subsidiary must be at least 90 per cent owned directly by the company invested in. The trading activity for which the money was raised may be transferred between such subsidiaries and the company invested in.

Other requirements
Other rules concerning the investment include rules relating to:
• the maximum size of the investment in any particular company that can count towards the VCTs qualifying holdings
• how the money invested by the VCT is used and the period within which it must be used, and
• the need for a minimum proportion of ordinary shares with no preferential rights to dividends or to the company's assets on its winding up, and no right to be redeemed, in the investment made by the VCT in any particular company.
How can a company find out if an investment in it by a VCT will be a qualifying holding?
The tax affairs of companies that a VCT has a qualifying holding in are dealt with by our Small Company Enterprise Centre (SCEC).
A company intending to accept an investment from a VCT can contact the SCEC to seek an assurance that the investment will be a qualifying holding. The company will need to provide all relevant information, including:
• latest available accounts for the company and any subsidiary company
• a share issue prospectus or business plan if available
• details of all trading or other activities carried on, or to be carried on, by the company or any subsidiary
• details of how the money invested in it by the VCT will be used
• an up-to-date copy of the Memorandum and Articles of Association of the company and of any subsidiary, and details of any changes to be made
• details of any subscription agreement or other side agreement to be entered into by the VCT

The Inspector at the SCEC will provide written confirmation if he or she is satisfied, on the basis of the information provided, that the conditions of the VCT scheme which apply to the company and the shares will be met.
If an investment is made in a company without that company getting an advance assurance, then it can still ask the SCEC at a later date to say whether the VCTs holding in it is a qualifying holding.

This article was written by the Inland Revenue and is available on its website.

Share this article

Latest Businesses for Sale

View more businesses for sale