The increase in the top band of income tax to 50 per cent on 6 April, the erosion of personal allowances for those earning over 100,000 and next year's cuts to the tax relief available on pension contributions made by high earners have sparked renewed interest in tax-efficient investments.
Venture capital trusts (VCTs) and enterprise investment schemes (EIS), which invest in small companies and start-ups, have been the biggest beneficiaries. The Association of Investment Companies (AIC) expects the total funds raised by VCTs to have doubled to around 300 million by the time the current tax year ends on 5 April.
Matthew Woodbridge, VCT manager at broker Chelsea Financial Services, said: "You have serial VCT investors and you increasingly have the high earners who want to offset the higher tax rate."
VCTs received a further boost in last week's Budget when the chancellor said the Treasury may increase the employee limit of companies in which VCTs invest from 50 to 100 or 250 and raise the annual investment limit for qualifying companies to 5m.
Tom Munro, of Tom Munro Financial Solutions, said: "Although VCTs and EISs are perceived as higher risk, investing into the sector as part of a well diversified portfolio will in my view provide excellent balance and with minimum investments starting at 3,000 for VCTs, there has never been a better time to consider the many opportunities on offer."
WHAT THEY DO
VCTs were introduced 15 years ago to encourage individuals to invest in fledgling companies, with generous tax breaks offered to offset the risk of investing in small enterprises.
VCTs, shares of which are listed on the stock exchange, have a similar structure to investment trusts, with the funds raised in subscriptions invested in a range of assets.
VCTs invested 973m in 384 unquoted UK companies in the five years ending April 2009, at an average investment of 2.5m. Companies in the leisure and hospitality sector benefit from the greatest VCT investment, accounting for 20 per cent of capital invested, according to the AIC.
Among the established players are groups including Baronsmead, Albion and Downing. Woodbridge commented: "There have been some really poor performers. But we do have some long-term track records these days that give investors an idea of who is good and who is not."
The tax reliefs are the chief reason for the increased demand from high earners, rather than the performance record. VCTs currently offer 30 per cent tax relief on investments up to 200,000 each tax year, provided the investment is held for five years. Dividends are also free of income and capital gains tax (CGT), while gains on the sale of VCTs are also CGT-free.
&149 TYPES OF VCT
Some VCTs are riskier than others, depending on their structure and focus. Investors wanting to limit their exposure to risk are often advised to focus on "planned exit" or "limited life" VCTs, which are typically wound up after five or six years, with proceeds distributed to investors. These have been particularly popular in recent months, according to Woodbridge.
"They have taken off this year because they tend to take less risk and return the capital you put in after six years. So far the providers with a track record available have all returned money and done what they said they would do."
Other types of VCT include: generalist, which invest across several industries; Aim-traded, which invest in companies listed on the Alternative Investment Market; and specialist, which focus on specific sectors, such as technology.
They are suitable only for those happy to keep their money invested for at least five years and who are comfortable with a high level of risk, as the performance record is mixed. The risk is also due to their low liquidity, with potential for investors to have problems selling their shares at a price that comes close to reflecting the value of the underlying assets.
VCTs can also be expensive, with 5 per cent initial charges – which are discounted if the investments are bought through a discount broker – and annual charges of around 3 per cent or more.