Jan 202014

This is the third in our series of articles on venture capital trusts. In this article we shall look at the conditions relating to the VCT itself. In particular, we shall look at the way the VCT is structured as opposed to the way in which the business is run, or the conditions attached to the investments in the underlying portfolio. These topics are the subject of future articles in this series.

(This article can be downloaded in pdf format in portrait or landscape version at Academia.edu.)

As a reminder, we are here on the roadmap:

Venture Capital Trusts - Roadmap - VCT

What are the main structural conditions?

There are in fact only two main conditions:

  • A VCT must not be a close company1 – which is, broadly a company with five or fewer participators; and
  • The company’s ordinary shares must be admitted to trading on a regulated market. This is the “listing” condition which until recently, meant that the company had to be listed on the London Stock Exchange. However, the rules have been modified so as to include any other regular exchange in the EU, which satisfies the relevant regulations2.

We shall deal with the listing condition in more detail below, but first, what is the reasoning behind these two conditions?

These requirements are in fact similar to those for REITs. The intention is that VCTs are targeted at retail investors to give them the opportunity to invest in high growth companies, which might otherwise have been unavailable. Accordingly, the close company and listing requirements ensure that VCTs have a diversity of ownership – they are open to all.

Furthermore, the listing condition means that in theory, there is a ready market for the VCT’s shares, both in terms of buying into the sector and in realising one’s investment. In practice however, VCT shares tend to be illiquid, and some companies actually offer their investors an exit route by buying back the shares at the end of a specified period. (Note however that there are rules restricting share buybacks in certain situations).

More about the listing condition – what is a regulated market?

There is a definition, which comes from an EU Directive. A regulated market is3:

“…a multilateral system operated and/or managed by a market operator, which brings together or facilitates the bringing together of multiple third-party buying and selling interests in financial instruments – in the system and in accordance with its non-discretionary rules – in a way that results in a contract, in respect of the financial instruments admitted to trading under its rules and/or systems, and which is authorised and functions regularly and in accordance with the provisions of Title III [of the Directive].”

Clear as mud. The HMRC Manuals are a lot more helpful4:

“The Commission issues a list indicating the titles of the individual markets which are recognised by national competent authorities as complying with the definition of ‘regulated market’. In addition, it indicates the entity responsible for managing these markets and the competent authority responsible for issuing or approving the rules of the market”

The list includes all member states as well as EEA members Iceland and Norway, and can be found in the Official Journal. One can see that familiar markets such as the London Stock Exchange and NYSE Euronext are on the list, but not AIM.

As stated above, the original listing requirement only applied to the main London market – the extension to overseas markets is recent. It will be interesting to see how many VCTs will actually take up the offer of going abroad. The key factors to consider will be the costs of an overseas listing and whether sufficient funds can be raised, bearing in mind that the tax breaks are unlikely to benefit foreign investors.

More about the listing condition – can a VCT be unquoted?

There are in fact two cases where a VCT can fail to satisfy the listing condition, and yet still retain its VCT status. These cases arise in the following circumstances:

  • In the start-up phase, when the company is first set up and issues its first prospectus; and
  • The winding up phase, when the company comes to the end of its life and starts closing down its operations.

We shall look at these two situations in turn.

When a VCT is unquoted – the start-up phase

The listing condition needs to be satisfied when the VCT first seeks approval, or at any rate by the end of the accounting period in which the application is made5.

However, it may not always be possible to achieve this condition, especially when the company is in the start-up phase. If this is the case, HMRC can grant provisional approval on condition that a listing is obtained by at least the end of the following accounting period6. HMRC may also specify other conditions to be fulfilled before full approval is granted, so it is important that the company’s application should set out what its plans are for listing, and how it proposes to achieve this requirement7.

As a consequence, the VCT can go ahead and raise money from investors, who will still qualify for upfront relief, even though this one crucial condition is yet to be satisfied. However, while there is a grace period, it is clear that the intent behind the rules is that the VCT should be listed as quickly as possible.

Liquidation – how does a VCT retain its tax status?

When a VCT goes into liquidation and comes to the end of its life, the shares may have to delist. This breaches one of the main VCT conditions with the consequence that investors would normally lose their tax breaks. In particular:

  • The most serious consequence is for those investors unlucky to be still holding their shares in the middle of the 5 year holding period. The withdrawal of VCT status triggers a deemed disposal of the shares, leading to a clawback of upfront relief previously granted8 – adding insult to injury if the investor is actually nursing a loss;
  • There is also a deemed disposal for CGT purposes, but this comes with the benefit of the exemption and so doesn’t lead to an immediate tax charge (but see the next point). Instead, the base cost is adjusted to market value – it is this new base cost that is used to calculate gains or losses on future disposals, which are no longer tax free9;
  • However, where the VCT shares are shielding a previous gain on another asset under the deferral rules, this gain is now triggered10. This only applies for shares that were issued before 6 April 2004, when it was still possible to defer a CGT liability in this way;
  • There is also a loss of the dividend exemption, but it is unlikely that a VCT going into liquidation will be paying a dividend. Anything left over for shareholders after all the other creditors have been paid, is likely to constitute a capital distribution11.

However, if the VCT goes into liquidation, the usual rules can be modified to ensure that investors aren’t hit by an immediate tax bill12. In order to benefit, the company needs to notify HMRC of the impending loss of VCT status13. Provided that the following conditions are satisfied, the company will continue to be a VCT:

  • The winding up must be for genuine commercial reasons14; AND EITHER
  • The company is being wound up by court order15; OR
  • The company has been a VCT throughout a continuous period up till the winding up date. This period is normally 3 years, but for those VCTs that first issued shares between 6 April 2004 and 5 April 2006, the period is extended to 5 years16.

However, the grace period is not forever. VCT status will continue until the company is dissolved or the winding up period comes to an end, and approval will certainly be withdrawn after three years, irrespective of whether either of these events has taken place by then17. It should however be stressed that the continued approval of the company’s VCT status doesn’t give it carte blanche to go out and break any other rules. The company can still lose its tax status if it fails to satisfy any of the other VCT conditions during the grace period18.

What are the tax consequences for a VCT in liquidation?

For the VCT, it retains the capital gains exemption19. This is particularly useful on realising those investments that may be standing at a gain – though of course, if most of the investments have proved to be duds, any gains would be absorbed by the losses.

As for the investors, all tax reliefs are preserved, with the exception of the dividend relief. But as noted earlier, this shouldn’t matter, since future VCT distributions are more likely to be capital. In summary:

  • Upfront relief is not clawed back for those unlucky to be still holding their shares in the middle of the normal 5 year holding period20;
  • The CGT exemption is preserved – so any capital distributions made during the grace period will be tax free, as well as any gains made on selling the shares (but who’s going to buy them?)21;
  • Deferral relief is preserved, but note that it can only be a matter of time until the deferred gain is triggered – the grace period will certainly have come to an end after three years22.

Let us take a closer look at the CGT position of an individual investor.

The effect of preserving the CGT exemption is particularly useful if the shares are standing at a gain. This would be the case where we have a successful VCT that has grown too large, and has decided to return capital to its shareholders.

However, where the VCT has been losing money, the investor doesn’t have the benefit of tax relief. Even if he still owns the shares when the grace period comes to an end, any tax relief he can claim for his losses will be restricted. As we noted, when the VCT’s approval is withdrawn, the base cost of the shares is adjusted to market value with the effect that the most substantial part of the loss is effectively wiped out.

For example, if the shares were issued for £1, but the market value has dropped to 10p when the company starts winding up, we have a loss of 90p per share. This loss cannot be claimed for as long as the VCT remains a VCT. Assuming that this value remains unchanged, the base cost is adjusted to 10p if the shares are still held at the end of the grace period, when approval is finally withdrawn. Losses can now be claimed but we are starting at a much lower level. The maximum loss that can accrue is now only 10p per share in the event that the holding is ultimately judged to be worthless.

This may seem unfair at first, but this is no different from the case where an investor sells his shares at a loss while the VCT was still a VCT. If tax relief was not intended on this occasion, why should it be granted simply because the VCT has decided to call it a day and liquidate?

Rounding off

This completes the third article in the series. In the next articles we shall come to the heart of the matter – what are the rules governing the way in which a VCT invests the money it has raised from its investors?


  1. ITA 2007 s 259(1)(a).
  2. ITA 2007 ss 259(1)(b), 274(2), 274(4).
  3. ITA 2007 s 274(4), Directive 2004/39/EC Art 4.1(14).
  4. HMRC Manual VCM54040.
  5. ITA 2007 s 274(1)(b).
  6. ITA 2007 ss 275, 275(3)(a).
  7. Venture Capital Trust Regulations 1995/1979 reg 3(4), 4(3) – see also HMRC Manuals at VCM54270, VCM54030 and VCM54300.
  8. ITA 2007 ss 266, 268. But those investors who have held for more than 5 years are safe – they are no longer in a position to lose their upfront relief.
  9. TCGA 1992 ss 151B(6), 151B(7).
  10. TCGA 1992 s 151B(8)(b)(ii), Schedule 5C paragraphs 3(1)(f), 4(1). Although the rules for deferral relief have been repealed, they still apply to historic cases where deferral relief was available but the gain is still locked inside a VCT investment – see FA 2004 Schedule 19, paragraph 7(2).
  11. Note that it is possible for a dividend to be paid after losing VCT status, having been declared prior to the event. Unfortunately, this dividend is now taxable, even though it relates to a period when the company was a bona fide VCT – see ITTOIA 2005 s 709(2)(a)(ii) which states that for relief to be available, the company must be a VCT at the time of payment.
  12. The Venture Capital Trust (Winding up and Mergers) (Tax) Regulations 2004 (SI 2004/2199) reg 1(2)(a) applying to VCTs  winding up under proceedings that started on or after 17 April 2002.
  13. SI 1995/1979 reg 8(1), 8A.
  14. ITA 2007 s 320, in particular, ss 320(1)(a) and 320(1)(c), defining the term VCT-in-liquidation, which is the phrase used in the Regulations.
  15. SI 2004/2199 reg 3(1)(b).
  16. 2004/2199 reg 3(1)(a), 3(2).
  17. 2004/2199 reg 2(2), 4 to 7.
  18. Note also there is another set of rules for VCTs that are in liquidation as a result of a merger with another VCT. We shall not be discussing this type of event in this article, but the rules are in the same set of regulations SI 2004/2199 (see also ITA 2007 s 323).
  19. SI 2004/2199 reg 5.
  20. SI 2004/2199 reg 4.
  21. SI 2004/2199 reg 6(1), 6(2).
  22. SI 2004/2199 reg 7(1).
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Satwaki Chanda

Satwaki Chanda

Satwaki Chanda is a tax lawyer with a First Class degree in Mathematics. Called to the Bar in 1992, he is the Editor of Tax Notes.
Satwaki Chanda

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  5 Responses to “Venture Capital Trusts Part Three – How is the VCT structured?”

  1. Excellent article. Will the recent Budget affect this?

  2. How likely is it that anyone overseas is going to invest in these on the foreign exchanges? Is this a EU requirement?

    • Satwaki Chanda

      I don’t know – I shouldn’t be surprised given that the definition is an EU. Presumably you’re referring to the idea that anything with a tax break needs to be EU-compatible, that is, not against the rules for State Aid. But I am only guessing.

  3. Excellent post. Many thanks, Brian.

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