Tax reliefs offered by Venture Capital Trusts

While VCTs are deemed to be high risk investments they do offer growth potential and appeal to higher and additional rate taxpayers due to the tax reliefs available. Broadly, it is possible to invest up to £200,000 in VCTs per tax year and receive 30% income tax relief, so up to £60,000. To benefit from relief, the investor must have an income tax liability and to keep the relief they must hold the shares for at least five years.

In this article I provide an overview of the tax incentives offered by VCT investments.

Income tax relief

As mentioned above, investors can claim 30% income tax relief on VCT investments. This means that if someone invests £100,000 in a tax year, they can claim income tax relief of £30,000 in the tax year in which the funds are invested. It is only possible to benefit from income tax relief against the income tax liability in the tax year in which the investment is made. 

It is important to note that income tax relief is applied against the investors’ income tax liability. This means that the relief can only reduce the investor’s liability to nil –  it is not possible to reclaim any unpaid tax from HMRC.

Example:

Mark recently received a cash legacy of £90,000 and would like to use this to carry out some planning.

Mark earns £130,000. He has three children, two of whom are in private education. Mark’s wife isn’t currently working as their youngest child is just 3 months old.

Given Mark’s earnings, he would lose all of his personal allowance. As a reminder the personal allowance is reduced by £1 for every £2 once total income exceeds £100,000. This means that for the current tax year the personal allowance is lost entirely once total income is in excess of £125,140.

Mark’s tax position is therefore as follows:

Income                                    £130,000
                                   
£37,700 x 20%                £7,540        
£87,440 x 40%               £34,976
£4,860 x 45%                 £2,187
                                       £44,703

Let’s say Mark uses his legacy and decides to contribute £30,000 (£24,000 net of basic rate tax relief at source) into his personal pension. His ‘adjusted net income’ will then reduce to £100,000 so he will be able to benefit from a full personal allowance. He also decides to invest £60,000 into a VCT. Remember the personal pension contribution has the benefit of providing higher rate relief by extending his basic rate band which Mark will need to reclaim with HMRC usually through his self-assessment tax return.

His revised income tax position will be as follows:

Income                                    £130,000
less PA                         (£12,570)
                                     £117,430
                                   
£67,700 x 20%               £13,540       
£49,730 x 40%               £19,892
                                       £33,432
Less income
tax relief at 30%         *(£18,000)
Revised position            £15,432

*£60,000 x 30%

Tax-free dividends

With a reduced dividend allowance of only £500 in the current tax-year, receiving tax-free income is likely to appeal to those who are higher/additional rate taxpayers. If their VCT investment pays dividends, there is no tax to pay on the dividends, therefore providing a source of tax-free income. There is also no requirement to declare the dividend income on the self-assessment tax return.

Tax-free capital gains

With the capital gains annual exemption having reduced from £6,000 to £3,000 in the current tax year, managing investment returns to limit the amount of tax payable is becoming increasingly difficult.

An investment in VCT shares means that provided the investor holds the shares for at least five years any capital gain will be tax-free. In practice, it is advisable to hold the shares for at least five years, otherwise any income tax relief will be ‘clawed-back.’

Remember though that it is no longer possible to defer a capital gain made on the sale of another asset by investing in VCT shares.

Summary

While VCT investments offer these tax incentives, whether or not these would be appropriate will very much depend on the individual’s circumstances, investment term and risk profile. Unfortunately, there is no guarantee that VCTs will maintain their VCT status. If qualifying status is lost, the tax benefits will be withdrawn from that point. In addition, if this happens within five years of making the investment, the individual will also be required to repay any upfront income tax relief that they had claimed.