David Prosser: Venture capital trusts face the chop

Outlook: Is the writing on the wall for venture capital trusts (VCTs)? Off-the-cuff remarks from George Osborne appear to suggest the Chancellor has a low opinion of the collective investment scheme, though it was launched by his cabinet colleague Ken Clarke when he was Chancellor under John Major.

On the face of it, that is unfair. As the Association of Investment Companies points out, the VCT sector has invested more than £2bn in 750 small companies since the scheme's creation. The funds are limited to only the smallest of businesses – they must have assets worth more than £7m at the time of the VCT's investment – exactly the sector of the economy that needs most support, especially in these times of constrained credit.

Such companies, by their very nature, are more likely to fail, so VCTs enable private investors, rather then big City institutions, to pool their assets across a spread of opportunities. Not a bad concept. And there is an incentive forpeople to chance their arm at this risky end of the investment spectrum as some generous tax reliefs are on offer.

To get rid of the scheme altogether would be a pity. Many of the businesses that have won VCT backing would have struggled to get finance anywhere else or, at the very least, been forced to go cap in hand to banks offering poor terms. Still, there may be a case for looking at the tax breaks, which do seem over-generous.

This is particularly the case with new VCTs, where the relief is more valuable than what's on offer if you buy shares on the secondary market (on the grounds that new investment is what the scheme is supposed to encourage).

Investors in these funds get 30 per cent income tax relief upfront – in practice, this means the value of the VCT has to fall by almost a third for its backers to fall into the red. And since VCTs only have to invest 70 per cent of their funds in qualifying holdings – the rest may be held in risk-free cash or gilts – this is less likely than one might imagine, even with risky assets.

Tax breaks for venture capital make sense. But these funds are aimed at wealthy, sophisticated investors and the scale of thegiveaway is over the top.