Tax savings by investing in VCTS

April 12, 2023|In KRW Tax Tips|By Keith Witchell

Venture Capital Trusts (VCTs) invest in emerging businesses and offer similar tax breaks to the investor as EIS and SEIS, but there are notable differences.

One key difference is around investment risk.  Clearly any investment carries risk, but where EIS and SEIS investments are seen to be high risk as they are investments into individual start-up companies that could fail, a VCT fund invests in a number of businesses, therefore spreading the risk.  VCT funds also usually have a strict vetting process for the companies they back and a desire for their funds to be successful to attract new investors, which again should help to mitigate some of the risk.

What kind of tax reliefs do they offer?  The first relief on offer is 30% income tax relief.  This means that for every £10k you invest into VCTs you will get £3 back in income tax.  Of course you need to have an income tax bill in order to get the relief (it only reduces income tax on your income, it can’t create a refund of tax if you don’t owe any), but providing you do, you can invest up to £200,000 per year into VCTs.  However, the relief can only be given in the tax year in which the investment into the VCT is made, and there is no option to relate this back to the previous tax year like there is with EIS and SEIS.

The second relief is that any dividends received from the underlying companies in a VCT fund are completely tax-free for the investor.  In contrast, dividends on EIS or SEIS shares are not tax-free, so this offers higher earners a useful tax-free income.

The third relief is that the sale of your VCT investments are free from Capital Gains Tax, after a qualifying ownership period of 5 years.  This qualifying period is longer than those for EIS and SEIS, but it does mean that any gains on the investments will be tax-free.  Plus if you do cash them in after 5 years, you can reinvest the proceeds into further VCTs, getting a second 30% income tax saving on your money.

However, you cannot roll over Capital Gains on other assets you have sold into a VCT investment, as you can with investments into EIS and SEIS shares.  So it isn’t the best option for those with gains they want to defer.

So, who might want to make a VCT investment?  While anyone can make a VCT investment, we have seen two types of clients recently that have found them really useful.

The first type is a company owner with lots of money building up in their trading company that they would like to get at.  If they take large lump sums out of their company, they will face dividend tax at (up to) 39.35%, but by putting those funds into VCTs they will get 30% tax relief, reducing the tax charge on extracting the cash to a maximum of 9.35%.  This represents a relatively low tax way to turn company cash into personal cash.  Any dividends generated by the VCT funds are tax-free and, providing the VCT funds are successful, the money can come back out after 5 years, or be reinvested into further VCTs for a further 30% tax saving on the funds reinvested.  For companies with accumulated cash reserves this is well worth considering, as an alternative to making investments via the company, and/or waiting for a future sale/winding up of the company in the hope of paying 10% tax on the accumulated funds.

The second type are property investors with buy-to-let properties held in their own names.  Over recent years successive tax changes have meant that those with high earnings that have mortgaged buy-to-let properties are paying disproportionately high levels of tax on their rental returns.  However, by investing their rental profits into VCTs they get the immediate 30% income tax relief, which helps to offset the punitive property tax.  Where property investors are not reliant on the income generated from the portfolio, and are holding them for future capital growth, this can represent an efficient way to mitigate the high income tax imposed on property rents.  Plus of course any dividend income generated by the VCT funds are tax-free and don’t therefore add to the annual income tax burden for property investors.

For further advice on the tax breaks for VCTs then please contact me, or reach out to Ben  or Alan at KRW Financial Planning, who can give further advice on this type of investment.

Key Facts

  • Venture Capital Trusts are managed funds that invest in emerging businesses
  • Investments of up to £200k pa into VCT funds receive income tax relief of 30%
  • Any dividends received on VCTs are completely free of income tax
  • After a qualifying period of 5 years, any gains from selling VCT funds are Capital Gains Tax free
  • They offer a low tax way to extract surplus cash from your company, or to mitigate property tax

For further advice on this matter, please contact me.

Keith Witchell