Written by FCSA Business Partner, Octopus Investments
Venture Capital Trusts (VCTs) invest in the UK’s smaller companies and they can provide contractors with an easy way to access the growth potential of these businesses. Many companies that started off with funding from VCTs have grown to become household names. Some have achieved a listing on the London Stock Exchange and some have been sold to global brands, such as Microsoft, Amazon, and Twitter.
VCTs also offer up to 30% upfront income tax relief, tax-free dividends and an exemption from capital gains tax on the shares should they rise in value. It’s important to understand that smaller companies can struggle in their early years, and some will not be successful. Therefore, the tax incentives are there to help compensate investors for the risk they take with their money. VCTs will place your capital at risk. Further details of the risks involved in investing in a VCT can be found below.
In the 2016/17 tax year, investors put £542 million into VCTs, the largest amount in a decade¹.
VCTs could help directors extract surplus cash from their company tax-efficiently
Many small business owners take a small, predictable salary from their company and, when the company is sufficiently profitable to do so, they choose to take additional income by way of dividends.
But while the introduction of the new £5,000 annual dividend allowance should result in individuals paying less income tax on modest share portfolios, business owners expecting to receive higher dividend income are likely to face a significantly higher tax bill.
Contractors comfortable with risks of investing in smaller companies who operate through a limited company could invest in a VCT to help them extract surplus cash from their company tax-efficiently. With upfront income tax relief of up to 30% of the investment, the contractor’s tax liability arising from a dividend paid to them by their company may be reduced.
We always recommend investors seek professional financial advice to help you with your financial planning. We cannot offer investment or tax advice.
VCTs could complement existing pension arrangements
Successive governments have reduced the amount of money individuals can invest tax-efficiently in a personal pension over their lifetime.
The current limit is £1 million. And it’s not just top rate taxpayers who are likely to be affected. Thanks to decades of compounding, even those investing fairly modest annual amounts throughout their working life could be forced to stop paying into their pension early or risk breaching the new limits. This could make life increasingly difficult for people facing a lengthy – yet underfunded – retirement.
Furthermore, following the introduction of a tapered annual allowance for additional rate taxpayers in 2016, the ability for higher earners to make annual pension contributions tax-efficiently is restricted to as little as £10,000 a year for those earning over £210,000.
A high earner who is comfortable with the high risks of smaller company investing could consider investing in a VCT, building a tax-efficient investment to sit alongside their pension.
VCTs are inherently different to pensions and ISAs and shouldn’t be compared to tax benefits alone. As mentioned above, we recommend you seek professional advice before deciding to invest.
Key risks of investing in a VCT
All investments contain an element of risk, and VCTs are no exception. In fact, because they invest in small, unlisted or AIM-listed companies, VCTs are high-risk investments. The value of an investment, and any income from it can fall as well as rise. You may not get back the full amount you invest.
It is important to note that tax treatment depends on individual circumstances and may change in the future. Tax reliefs depend on the VCT maintaining its VCT-qualifying status.
VCT shares could fall or rise in value more than other shares listed on the main market of the London Stock Exchange. And they may also be harder to sell as there isn’t an active secondary market for VCT shares in the way there is for larger listed companies.
If you would like to find out more information about VCTs, please click here >
To speak with one of our team call 0203 142 4981 or email firstname.lastname@example.org.
¹Source: The Association of Investment Companies, April 2017.
Personal opinions may change and should not be seen as advice or a recommendation. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. Issued by Octopus Investments which is authorised and regulated in the UK by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. VAT No. 766 0776 96. Issued December 2017. We record telephone calls. CAM06194.
by Mark Williams, Head of SME Business Solutions