Entrepreneurs enjoy the ability to mould their own life, work when and how they want, and invest into a range of different businesses.
They need the guidance and advice of their trusted professional team, their solicitor, their accountant and of course, their financial adviser.
Business owners and entrepreneurs enjoy finding new ways to use their profits for themselves, their businesses and their families. But the reality is that many may find their money squeezed, not only due to the increasing costs of operating a business during this period of high inflation, but also as a result of the reduction in the dividends and capital gains allowances, the freezing of the personal allowance and for some, the increased rate of corporation tax.
In an ever-changing taxation environment, the options to mitigate tax are often met with delight. Now, do not worry – this is not another article on pensions! Although I’m sure you appreciate their central place in a business owner’s financial plan. No, this article explores the use of a Venture Capital Trust (VCT).
The UK Government introduced VCTs in 1995 to encourage investment into unquoted small to medium-sized businesses as a way of stimulating economic growth and creating new jobs. A VCT, much like an investment trust, purchases shares of and/or lends money to a range of businesses, and the individual investor invests into the VCT[1]. By investing into small to medium-sized businesses with the expertise and knowledge of a professional VCT fund manager, individual investors can enjoy greater diversification as opposed to investing directly into smaller companies, which would pose significantly higher risk – although it should be noted that investing into a VCT would still be deemed high risk due to the size of the companies that make up the underlying assets of the VCT – investors should therefore have an appropriate risk appetite, investment time scale and capacity for loss.
The funds within a typical financial plan are often invested into mainstream markets, which are priced daily and fluctuate regularly with market sentiment and breaking news stories. However, the businesses owned as part of a VCT are unquoted and are therefore less likely to be impacted by market sentiment and breaking news in the same way – although naturally they may be indirectly impacted.
Investing into a VCT will of course not be suitable for everyone; however in 2023/2024 £882 million of investors’ money was invested into VCTs, which is the third highest since the record £1,112 million set in 2021/22. This will undoubtedly help several businesses seeking alternative sources of finance at a time when borrowing costs have increased[2].
While it is important to highlight the good old saying that ‘the tax tail should not wag the investment dog’, it is clear that a number of investors are drawn to VCTs as part of their broader portfolios due to the available tax relief and tax exemptions, which are ultimately a reward from the UK Government for investing into smaller to medium-sized businesses, which as at the start of 2022 made up 99.9% of the business population[3].
Investors can enjoy tax relief on their investment into a VCT of 30% as long as they hold their investment for a minimum period of five years. For example, if an investor invested £50,000 into a VCT, the investor would be entitled to tax relief to the tune of £15,000. It is important to note that the maximum investment into a VCT is £200,000 and therefore the maximum tax relief available is £60,000. It is also important to note that an investor cannot claim tax relief in excess of their own tax liabilities – they would not be entitled to a tax rebate.
In addition to the tax relief on entry into the VCT, investors can also enjoy tax-free dividends (which can help diversify the income streams for the investor), as VCTs are typically managed to not have capital growth (although exempt from CGT if a gain does arise via disposal relief) and instead paying out special dividends as and when underlying companies within the VCT come to fruition.
Now let’s look at an example of how a financial plan can be constructed using VCTs.
John is a business owner who has £20,000 of profits available with no specific plans. He has maximised his contributions to his self-invested personal pension (SIPP) and his stocks and shares Individual Savings Account (ISA) and is therefore looking at other ways to invest, specifically for long-term growth. He has an investment timescale of 15 years plus and is comfortable investing into small to medium-sized companies. He has £50,000 in personal cash, which he retains for emergencies, and it has been determined that his capacity for loss is high.
John is advised to invest £20,000 into a VCT and is entitled to £6,000 tax relief, meaning that this amount will be deducted from his overall income tax liability.
Over the course of the next year, the VCT pays John dividends at rate of 5%[4] or £1,000, which John puts towards Christmas for his children.
The following year, John is in a similar position and invests a further £20,000 into a new VCT. In fact, he can do this every year.
In year six, he has now held his first VCT for the minimum period of five years and is looking to sell his investment. Having enjoyed tax-free dividends at an average of 5% per year, John considers how he could maintain this investment while being in receipt of the proceeds. John sells his VCT to his SIPP, at the current share price of the VCT, moving the VCT into his SIPP, which will now benefit from the dividends he has enjoyed. John now has further capital, which can then be used to invest into a VCT for the new year, again allowing him to benefit from 30% tax relief.
In year seven, John follows a similar process as laid out above with the VCT he invested into in year two.
It should be highlighted that investors are not obliged to sell their VCT after the minimum five-year period. Should they wish to sell their VCT completely as opposed to moving it into a SIPP as outlined in the above example, it can be sold in the open market using the services of a stockbroker or through a share buyback facilitated through the manager, which is the most common route.
The scenario above is only one example of how an investor can use VCTs as part of a broader financial plan and is not intended to constitute financial advice. Investment into a VCT is considered high risk and is not appropriate for all investors. If in doubt, please speak to a financial adviser.
At Mattioli Woods, we offer a dedicated VCT service where we conduct all necessary due diligence into the various VCTs and providers on the market to arrive at a shortlist of suitable plans.
Important information
As with all investments, your capital is at risk. VCTs are considered high risk and are not suitable for all investors. The value of your investments and the income from them may fall or rise and there are no guarantees. Past performance is not a guide to future returns. Tax treatment of investments and income depends on an individual’s circumstances and may be subject to change in future. The content of this article is for information only and does not constitute advice.
[1] VCM50010 – VCT: overview of the VCT scheme – HMRC internal manual – GOV.UK (www.gov.uk)
[2] VCT fundraising is third highest on record | The AIC
[4] The declared level of dividend returned in this scenario is a general targeted rate across VCT providers. This level of dividend may or may not be met in reality.
All content correct at time of writing.
