Venture Capital Trusts – tax-efficient investing in young companies

It is estimated that around 4.2 million people now pay Income Tax at the higher rate and a further 364,000 at the additional rate. Yet the options for mitigating high Income Tax bills have become more limited in recent years. This is because the amount that can be invested in pensions – the traditional first port of call for reducing an Income Tax liability – has steadily been restricted through reductions. This is in both the amount than can be accumulated in them over a lifetime (the lifetime allowance) without incurring penalties, as well as the amount which can be invested in pensions each year.

One of the most recent moves to ration access to pension tax reliefs has been the introduction of a tapered annual pension allowance for higher earners. The usual £40,000 annual allowance reduces by £1 for every £2 of income above £150,000, down to a minimum of £10,000 for those with an income of more than £210,000.

As a result of these restrictions, there has been increased interest in alternative HMRC-approved tax-efficient investment schemes from investors who are already maximising core tax-efficient allowances (such as pensions and ISAs). In particular, there has been increased interest in Venture Capital Trusts (VCTs), and the 2017/18 tax year saw the highest level of new VCT investment in a decade.

What are VCTs?

VCTs are a type of tax-efficient investment that was created by the Government in the mid-nineties to encourage investment into smaller UK companies that are either unquoted or traded on AIM (the London Stock Exchange’s junior market). Companies that qualify for VCT investment must meet a variety of criteria based around their size, age, activities and how the financing will be used. While the rules around the types of company which qualify for VCT investment and the tax reliefs have changed over the years, both Conservative and Labour governments have supported VCTs as they have recognised that small enterprises are important to the dynamism of the UK economy.

VCTs are structured as investment companies with shares listed on the London Stock Exchange. They invest in diversified portfolios of qualifying fledgling businesses which are selected by a professional management team. VCT managers are usually either private equity companies or, in the case of AIM-focused VCTs, often fund management firms with strong expertise in smaller company investment. VCTs will typically have a close ongoing relationship with the companies they back, often placing directors on their boards to monitor the investment and steer it towards an eventual sale or listing.

However, unlike other investment companies (such as investment trusts) VCT investing provides UK individual taxpayers with various tax incentives in recognition of the higher risks involved:

• 30% Income Tax credit when subscriptions are made to VCT new shares issues (repayable if the shares are sold within five years)
• Tax-free dividends
• Tax-free capital gains

Up to £200,000 can be invested in VCTs by UK individual taxpayers each tax year, meaning a potential maximum Income Tax credit of £60,000 where all investments are made into new share issues.

Who might benefit from VCTs?

VCTs are specialist investments and should be regarded as higher risk because the companies they invest in are illiquid and early-stage. They are not suitable for novice investors, those who cannot tolerate the potential for losses or who do not have portfolios of other mainstream investments such as funds, main exchange listed companies and bonds. VCTs should only represent a modest part of an overall investment portfolio. As VCTs carry numerous tax incentives, they are not suitable for non-taxpayers and a typical VCT investor will be subject to the higher or additional rates of Income Tax. Please see the important information at the bottom of the page before investing.

Examples of people who might consider VCTs include:

• Investors who are already maximising their annual ISA and pension allowances and have further cash to invest
• Investors who have reached the pension lifetime allowance and want to supplement their retirement income strategy by investing in VCTs for tax-free dividends
• Higher earners with a total income over £150,000 who are affected by the tapered pension annual allowance and wish to reduce their Income Tax bill
• Investors who want to add some exposure in their portfolios to small, young UK enterprises with growth potential, or diversify their portfolio with exposure to unquoted companies

How we can help

At Tilney our financial planners will consider the use of VCTs and other approved tax-efficient investments including ISAs, pensions and Enterprise Investment Schemes (EIS) depending on a client’s individual circumstances and their suitability.

If you would like to know more about how we might be able to help create a tax-efficient investment strategy please contact us on 020 7189 2400, email contact@tilney.co.uk or book a no-obligation initial consultation.