What are Venture Capital Trusts?
Introduced by the government in 1995, the Venture Capital Trust (VCT) scheme is designed to encourage individuals to invest indirectly in a range of unquoted smaller, higher-risk trading companies.
Similar to investment trusts, VCTs are managed by fund managers who are usually members of larger investment groups. Investors subscribe for shares in a VCT that invests in qualifying trading companies. This, in turn, provides young businesses with funds to help them develop and grow.
To encourage support for these businesses the government offers generous tax benefits for VCT investing.
3 tax advantages for investors using VCTs
To help encourage people to invest into higher-risk companies, VCTs offer three tax benefits, making them a potentially beneficial choice for some higher- and additional-rate taxpayers.
1. Income Tax relief
Investors receive 30% Income Tax relief on investments up to £200,000 each year. So, if you invested £10,000, you could claim £3,000 tax relief, which you can deduct from your existing tax liability.
To qualify for this tax relief, you need to:
- Have paid at least as much tax as the rebate
- Hold the shares for at least five years.
Another point worth making is that, when you invest, the tax relief certificate is usually provided within two to three weeks, making it a far quicker process than you might see with other similar investments, such as the Enterprise Investment Scheme, that you may have read about previously.
As long as you hold the VCT for five years, you can choose to take your tax relief at the end of the investment period. Plus, you can normally choose when to sell your shares, which gives you more flexibility.
2. Tax-free dividends
Dividends from VCT shares are free of Income Tax.
Tax-free dividends can be used to supplement an investor’s income. This could be useful, especially for those approaching or in retirement.
3. No Capital Gains Tax
When you sell your VCT shares, you won’t be liable to Capital Gains Tax (CGT) on any profits.
These three tax benefits are only available to individual investors. They do not extend to trustees, companies, or others who invest in VCTs.
An additional note on VCT tax benefits
It’s worth noting that the exemption from Income Tax on dividends, and the exemption from CGT on disposal, are available to those who acquire the shares second hand (such as on the stock market or by inheritance). However, the front-end Income Tax relief is available only to those subscribing for new shares.
How to pick the right VCT for you
There are three different types of VCT: generalist, AIM, and specialist.
Generalist VCTs invest in a wide range of small, usually private companies in a range of sectors, and tend to be the most common.
They usually offer investors diversification across many early stage companies, and fund managers will often actively work with businesses to help them grow and succeed.
VCTs often look to back established entrepreneurs and some target particular types of company or sectors.
AIM VCTs invest in new shares issued by AIM-listed companies and target tax-free growth as well as income. Because these VCTs are investing in listed firms, the price can be more volatile. This is because the underlying companies are constantly being valued by the stock market rather than assessed periodically, as with unlisted businesses.
However, since ordinary shares are more easily sold on the market, the increase in volatility comes with a little more flexibility for investors to enter or exit investments.
There are also specialist VCTs which focus on just one sector, as well as rare hybrid trusts which invest in both generalist and AIM companies.
Who should consider including VCT investments as part of their financial plan?
First Wealth often recommend VCTs for business owners with substantial income who are looking for ways to reduce their tax burden.
VCTs are only suitable for UK resident taxpayers with an appetite for risk and a time horizon greater than five years.
Since VCTs are a higher-risk investment, they should only be considered as an addition to a well-diversified portfolio of other investments, such as pension savings and ISAs.
Because of the nature of underlying assets in VCTs, they are highly illiquid. While there are regular windows when you can sell your shares, they only come around three or four times a year. So, unlike with other equity investments, you can’t release capital whenever you need to. This could mean that you experience difficulty or be unable to realise your shares when you want to.
Tax levels and reliefs may also change, and the availability of tax reliefs will depend on individual circumstances.
2 examples of who can benefit from using VCTs as part of their financial plan
1. Successful young business owners
Due to the tax-free dividends they can provide, VCTs are a great solution for young entrepreneurs looking to increase the level of income they have.
However, using VCTs to increase income involves a slight balancing act. VCTs are only suitable for those who are financially secure and comfortable with investment risk. And young investors must be happy to tie their capital up for at least five years.
In these cases, we sometimes suggest younger clients start to build up a portfolio of VCTs that will start to pay out dividends here and there.
Over a couple of years, we’ll typically start to build up this pot of VCTs. Overtime, this will give clients tax relief at 30%, reducing their tax liability at the end of the year. Then, the tax-free dividends should help to top up the investor’s income over and above what they had before.
2. Business owners at or approaching retirement
VCTs can prove to be a tax-efficient complement to pensions for those at or approaching retirement.
With limits for annual pension contributions at £40,000 and the Lifetime Allowance (LTA) at £1,073,1000 for the 2022/23 tax year, the tax benefits of pensions are not what they were a decade ago.
Exceed these limits and you risk being taxed punitively.
However, because VCTs are not included in these limits – and you can currently invest up to £200,000 a year – they can make a great complement to existing pension arrangements.
For retirees, the 30% Income Tax relief on investments can act as a significant risk counterbalance or – should the investment do well – an added bonus.
With any capital gains made on the VCT also free from CGT, for investors hitting their pension allowance limits, the extra breathing space offered by VCTs can help put their savings to work and provide tax-efficient retirement income.
Plus, the Income Tax deduction can be useful for investors with a significant tax bill to pay for the year – for example, if you sold your business or received a generous bonus before retirement.
One First Wealth client has been investing in VCTs for years. She currently has about £1.5 million invested in VCTs, paying out anywhere between £50,000 and £70,000 in dividends each year – enough to cover her lifestyle.
And remember, there’s no tax liability on dividends either.
This strategy also allows you to protect your pension savings, which generally fall outside your estate for Inheritance Tax purposes.
VCTs generally suit experienced or wealthy investors
VCT investments are geared towards experienced or wealthy investors with large, diversified investment portfolios.
As with the clients described above, they can be particularly attractive to investors with a high Income Tax bill who are looking for growth opportunities or a tax-advantageous way to supplement their income.
VCTs could also appeal to investors with substantial CGT liabilities.
Get in touch
We specialise in advising business owners and entrepreneurs and work with you to keep your finances on track while you grow your business. While most financial planners focus on your money, we focus on you, your business, and the life you’re working hard for.
Venture Capital Trusts are complex investments, not suited to everyone. They can be ideal for higher risk investors with a high level of income and a high tax bill. If you’d like to discuss whether VCTs could help you achieve your goals, please get in touch.
Email email@example.com, book a video call, or phone us on 020 7467 2700.
This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.