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Government»Funds that give you tax breaks for going green

»Wednesday, April 28,2010

Venture capital trusts that invest in clean energy could be the way ahead. Investors are being offered tax breaks for going green with a new breed of venture capital trust (VCT) that invests in clean-energy companies.

VCTs are a type of fund that give investors 30% tax relief on new investments of up to £200,000, in addition to tax-free growth and dividends. They were created to boost growing companies, so they are a suitable match for the fledgling clean-technology sector, particularly as firms have been struggling to access bank finance.

The value of green VCTs has tripled from just £12.5m two years ago to about £37.5m now, according to Martin Churchill of Tax Efficient Review, an investment advisory firm.

He thinks they could become even more popular, driven partly by changes to the rules on pensions tax relief, which will be reduced from 50% for those on £150,000 to 20% at £180,000 from next April. This is prompting investors to supplement their pension savings with alternatives such as VCTs.

 

 

 

 

“VCTs were never designed to generate large capital growth but rather a steady, reliable return,” said Churchill, “so if you are looking for an alternative to your current pension and something to provide a stable tax-free income stream, as well as something that’s good for the environment, then these funds are a good option.”

The clean-energy industry’s most recent boost came from the Crown Estate, which last week awarded a handful of energy companies £100 billion-worth of contracts to build large-scale, offshore wind farms as part of the government’s plan to derive a third of the UK’s energy from wind by 2020.

However, government subsidies for smaller onshore wind farms — and other forms of green power — are likely to be more attractive to VCTs.

In April, a new system of “feed-in tariffs” will be introduced, under which households and businesses will be able to sell back to the grid the energy they generate, whether that’s through wind farms, solar panels, or combined heat and power units.

The tariffs apply only to “local-scale” projects that generate up to five megawatts of energy at a typical cost of between £1m to £20m. VCTs can invest only in firms or projects with maximum gross assets of £7m.

Matt Taylor of Foresight Group, the alternative asset manager, which recently launched two green-themed VCTs, said the firm was looking to expand its environmental portfolio this year to take advantage of the feed-in tariffs.

For example, if Tesco owns a large industrial site on which it wants to install wind turbines, it could use a VCT to provide part of the finance. Those turbines could generate up to 5MW of electricity, the sale price for which would be guaranteed under the feed-in tariffs — in effect a guaranteed income stream.

“Feed-in tariffs provide greater predictability for investors and we believe there will be a strong demand as a result, so we are now looking to invest in onshore wind, as well as hydro and biomass power projects,” said Taylor.

VCTs that invest in environmental assets have largely beaten more general schemes, according to Richard Allen, a consultant for Allenbridge, the tax shelter specialist.

He points to Climate Change Capital’s Ventus Funds, which have £50m invested in small to medium-sized onshore renewable energy projects in the UK.

The funds have outperformed the bulk of their peer group, delivering an average annual return of 5.3% since their 2005 launch. When taking into account the 30% tax break on VCTs, the average return jumps to 14.4%, according to Allenbridge.

Matthew Ridley of Ventus said the firm would likely seek further fundraising this year to broaden its stake in a range of clean energy sectors, including onshore wind, landfill gas, hydro-electric and biomass.

Another new green VCT comes from Acuity Capital. It is seeking to raise £20m to back environmental projects that convert household and commercial waste such as leftover food into a form of renewable energy that can be used to heat and light homes and even power cars.

The targeted annual dividend is 10%, equating to 13.3% gross. After factoring in the upfront 30% tax relief, this will amount to a handsome 19% return.

Nick Ross, the firm’s managing partner, said the idea for the green rubbish fund grew out of legislation aimed at reducing the amount of waste local authorities and businesses send to landfill.

Britain currently dumps about 270m tonnes of rubbish into landfill each year. The government has a national target to cut household waste by at least 40% this year and halve municipal waste volumes. To meet its objective it has imposed an annually increasing tax on each tonne of rubbish sent to landfill.

The current tax rate is £48 a tonne. The National Audit Office estimates the fines could more than double by 2013.

“Acuity’s fund is attractive because the earnings are backed up by the obligation on local authorities and companies to reduce the amount of waste they send to landfill,” said Churchill.

Kavita Patel of Martineau, the advisory firm, said: “There are some good returns to be made in this market and it’s something that is close to the heart of most people, so a number of managers are gaining interest in environmental VCTs.”

However, she cautions that VCTs should still be viewed as high-risk investments. “The difficulty is that many environmental projects only come good over the longer term, whereas newer VCTs tend to wind-down after just five or seven years.”

An additional difficulty is that investments in a single company are currently capped at £1m, but the nature of most environmental projects means they need significant financial backing.

VCT GUIDE

- VCTs invest in unquoted businesses with gross assets of up to £7m.

- They attract 30% upfront tax relief on investments of up to £200,000 a year. Investments qualify if held for five years.

- Tax-free growth and dividends.

- Some VCTs are “planned exit” or “limited life”. They usually aim to wind up after five years and are used for tax breaks. The Revenue is considering a clampdown.

- A VCT can keep 30% in cash. Of the other 70%, 30% must be invested in the firm’s shares.

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