Wealth

Venture Capital Trusts – A Tax Efficient Income Solution

Venture Capital Trusts (‘VCT’s’) were introduced in 1995 as a means of encouraging investment into small unquoted trading companies. Many have grown to become household names, achieving full listings on the London Stock Exchange and others have been sold to global brands. VCTs listed on the London Stock Exchange are similar in that respect to investment trusts. They are typically run by fund managers who use their expertise to invest across a number of companies to mitigate risk.

VCTs offer growth opportunities as smaller companies have a greater potential to grow than their larger counterparts, and the potential for attractive dividend yields is further enhanced through tax incentives.

Investment in VCTs is limited to £200,000 each tax year and offer the following tax benefits:

  • income tax relief at 30% of the initial investment
  • CGT exemption on disposal
  • tax-free dividends

For example, Louisa (age 60) made an investment of £20,000 and could have obtained £6,000 immediate income tax relief.

The relief can only be offset against the income tax liability in the tax year of investment but covers any income giving rise to income tax whether earned e.g. PAYE or unearned e.g. rent and interest. The VCT must be held for a five-year period to retain the relief. When sold there is no CGT liability provided the VCT still meets the relevant criteria.

Given the higher risk nature of VCTs an investment strategy of building up a portfolio over a number of tax years can be attractive. Assuming that Louisa continues the strategy for a further four years, she would build up a portfolio of £100,000, having received tax-free income over this period but also up to £30,000 of up-front income tax relief.

If her portfolio created tax-free dividends of 5% per annum (not guaranteed), this would be a tax-free income of £5,000 per annum, whereas taxable dividends would need to achieve 7.4% for a higher-rate taxpayer and 8.1% for an additional-rate taxpayer to achieve the equivalent return net of tax, assuming no personal allowance or dividend allowance.

In year six Louisa retires and is now enjoying income from several sources, including rental income, pension and ISA, but has no earned income. Rather than subscribe new money to a VCT, Louisa could sell the investment placed five years ago and buy ordinary shares in a new VCT. The investment could qualify for a further 30% income tax relief against her unearned taxable income. Care should be taken on refreshing income tax relief as there are now rules preventing reinvestment in linked sales.

While this article focuses on the tax benefits of investing in VCTs, advice should be sought over an appropriate portfolio of investments and tax advice from an accountant or qualified tax professional. The market has matured considerably from the early days of 1995 and today represents a good planning opportunity for clients with the right risk profile as part of a balanced investment strategy.

 

This document has been produced for information purposes only. It is not intended to be an invitation to buy or act upon the comments made. All investment decisions should be taken with advice, given appropriate knowledge of the investorʼs circumstances and one must satisfy certain investor criteria before being considered eligible to invest. Any forward-looking statements and forecasted returns represent the current views of Mattioli Woods plc and may be subject to change. Your capital may be at risk and past performance is not a guide to future returns. Mattioli Woods plc is authorised and regulated by the Financial Conduct Authority.

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