One of the main attractions of putting money into a pension is the tax-relief that you receive.
If a basic rate taxpayer pays £80 into a pension, this is immediately ‘topped up’ by the Government to £100. A higher rate taxpayer can claim an extra £20; taking the net cost to just £60.
Whilst pensions have certainly had a new lease of life following the introduction of Pensions Freedom in April, one of the criticisms still leveled at pensions is that you can’t access your money until 55. Indeed, from 2028 this age will start to increase in line with the State Pension age.
A further problem with pensions is that the amount you can pay in each year, and therefore obtain tax-relief on, is being squeezed. The Annual Allowance has been reduced to £40,000 per year and drops to just £10,000 for people who have started to take an income from their pension under new Flexi Access Drawdown rules.
Therefore, for higher earners, or those people with fluctuating earnings, which rise and fall steeply, the new rules may mean they can pay less into their pension than they would ideally like.
So if tax-relief when you invest is attractive, but you don’t like tying up your money until the age of 55, or you have already paid the maximum possible into a pension, what is the alternative?
Step forward the Venture Capital Trust (VCT).
First things first, what is a VCT?
A VCT is actually a limited company which itself invests into smaller companies looking to expand.
Whilst the tax breaks for investing in a VCT are attractive, the risks are higher than those normally associated with a ‘mainstream’ investment. Because the companies which the VCT invests into are smaller they are more likely to fail, thereby putting an investor’s capital at risk.
VCTs are quoted on the London Stock Exchange and have a share price, just in the same way as other companies.
How does the tax-relief work?
Investment into smaller companies via VCTs is important for the economy; the Government therefore attempts to stimulate interest by offering income tax-relief as well as other concessions;
- Income tax-relief is available at up to 30% on investments of up to £200,000 per tax-year, as long as the VCT held for at least five years
- The maximum tax-relief available is capped at the amount which would reduce your income tax liability in the tax-year in question to zero
- When you sell the investment any profit is exempt from Capital Gains Tax (CGT)
- Some VCTs pay dividends, these are exempt from income tax, even for higher rate taxpayers
The investments bought by the VCT fund manager must also meet certain restrictions.
How is tax-relief claimed?
A VCT will provide each investor with a certificate that they may then use to claim their income tax relief. The claim can either be made immediately by contacting their Tax Office and obtaining an adjustment to the tax coding under the PAYE system, or via completion of the annual tax return.
Tax-relief is not automatic and if you invest into a VCT you need to apply for the claim yourself.
If the investor does not pay tax under PAYE, but is due to make Self-Assessment payments on account, they can, subject to certain conditions, make a claim to reduce these. To receive the relief this way, the investor should contact their Tax Office and ask for confirmation of the qualifying conditions for making a claim to reduce payments on account.
Whichever method is used to claim income tax relief, the investor must enter details of the investment on a tax return for the tax year in which the VCT shares were issued.
Advantages of a VCT
- Tax-relief of up to 30% of your initial investment is available
- Any gains you make, or income you receive, is free from tax
- Subject to the necessary liquidity you can access your investment at any point, although if you are to retain your original tax-relief the VCT should be held for at least five years
- For adventurous investors it can be an attractive way of investing in smaller companies which are not traded on the stock market
Disadvantages of a VCT
- VCT investments are by their very nature high risk and there is a significant possibility that you could lose some or all of your capital
- If the shares in the VCT are sold within the first five years the tax-relief paid to the investor will be clawed back
- A VCT is designed to be a medium to long-term investment, the market for selling the investment is therefore likely to be illiquid especially during the early years as tax-relief is not available to a ‘second hand’ purchaser
- If the VCT breaks the rules you may have to repay back the tax-relief you have received
- The costs of investing into a VCT are often higher than those of a more ‘traditional’ investment
We’re here to help
VCTs are not right for everyone, in fact they are probably only appropriate for a handful of investors. However, if the tax-relief is attractive, you are happy to invest in smaller companies and accept the risks that this brings and you don’t want to wait until 55 to access your investment (or indeed you have paid the maximum amount possible into a pension already) a VCT could be worth considering.
If you would like to know more about VCTs we are here to help, call Sarah or Bev today on 0115 933 8433 or email firstname.lastname@example.org