This is the second in a series of articles on venture capital trusts. In Part One we looked at the tax breaks on offer for those brave enough to risk their capital. In this, and the next article, we shall take a closer look at the investors - who they are, how they can invest, and what are the strings attached to the investment.
We are here on the roadmap:
We have already covered these in Part One, but a short recap will do no harm. There are three types of relief:
All reliefs are lost if the tax status of the VCT is withdrawn.
The key to understanding the conditions is to remember that these investments carry a high degree of risk. The bargain between investors on the one hand and HMRC on the other, is that the tax breaks are awarded in exchange for taking on this risk. This bargain would be broken if it were possible to structure an investment in such a way that reduces the chances of investors losing their money.
The following are the main conditions as they apply to investors:
Three further conditions relate specifically to upfront relief:
In the rest of this article we shall look at the requirement for the investor to take equity and the meaning of "eligible" and "ordinary shares". We shall look at the rules on linked loans and linked sales in the next article in the series.
Note that relief is only available for equity, rather than debt. In particular, the shares must be ordinary, as opposed to preference shares. This is the riskiest class of security - while the prospect of rewards is great, ordinary shareholders rank last in the line of creditors if the company goes bust.
There are in fact, two types of ordinary shares that are relevant:
For tax purposes, ordinary shares are any type of share except for fixed rate preference shares. As the name suggests, the latter carry a right to a fixed rate dividend, but no other rights to the company's (income) profits.
It makes sense to exclude fixed rate preference shares, as this type of security has more features in common with a debt instrument, and is therefore a "safer" form of investment. However, for tax purposes, ordinary shares can still be preferential in nature, without losing their "ordinariness".
For example, we can structure a particular class of shares so that:
The class of investors holding these shares are clearly better off than the others who have to "wait in the queue". But in spite of the preferential nature of their holdings, they are still ordinary shareholders by virtue of the definition.
However, for the purpose of upfront relief, this type of ordinary share is not permitted. Shareholders who have a preferential right to assets and/or can redeem early, have clearly mitigated some of the risk that attaches to a VCT investment. Accordingly, particular restrictions are placed on the ordinary shares when they are issued.
In order to qualify for upfront relief, the shares must be "eligible shares". These are ordinary shares satisfying the following conditions:
These restrictions last for 5 years starting from the day that the shares are issued. Note that this coincides with the holding period applicable to upfront relief.
The difference between eligible and ordinary shares can be summarised in the following diagram.
This completes Part Two of our series on VCTs. In the next part, we shall take a closer look at the rules on linked loans and linked sales.
The above article can be downloaded in PDF format at Academia.edu.
Related Articles: Introducing Venture Capital Trusts: Part One - What Are The Tax Breaks?.Back to Articles Back to Satwaki Chanda
The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.
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