A growing number of individuals are looking to diversify their investment portfolios and access alternative asset classes such as venture capital and private equity, without the high minimum investment amounts which can often apply in this space.
For these investors, Venture Capital Trusts may be a tax-efficient opportunity to invest in entrepreneurial businesses. Here, Simon Bashorun, Divisional Director for Wealth Advisory at Investec Wealth & Investment, explains more.
1) What is a VCT?
In simple terms, a Venture Capital Trust is a listed collective investment vehicle which allows investors to access smaller, unquoted companies. The companies are privately owned or listed on the Alternative Investment Market (AIM).
To qualify for VCT funding, HMRC states that the businesses must be less than seven years old, with less than 250 staff and less than £15m gross assets. They must promote innovation and industrial change.
2) How do the clients you work with use VCTs as part of their financial planning and investment management?
At Investec Wealth & Investment we work with a number of experienced investors – including finance professionals – who want to diversify their existing portfolio in a tax-efficient way.
These individuals have an understanding of market volatility and are comfortable with exposure to risk. Their income profile means they have the liquidity to fund these investments and they are also likely to have utilised existing tax allowances available through ISAs and pensions.
An investment in a VCT must be held for at least five years to benefit from tax incentives and therefore, these individuals invest with long-term objectives in mind.
3) What are the tax incentives for VCT investing?
To encourage investors to support entrepreneurial businesses, VCTs come with a number of tax advantages. Each year, investments of up to £200,000 benefit from a 30% upfront Income Tax relief. Any dividends received are tax-free and do not need to be declared on your return, and any capital gains on the eventual sale of shares are tax-free too. Investments must be held for at least five years.
At Investec Wealth & Investment we work with a number of experienced investors, including finance professionals, who want to diversify their existing portfolio in a tax-efficient way.
4) What are the risks?
Investments in small companies are often high risk and you may get back less than you invested.
In addition, the secondary market for VCTs is limited which may make the asset relatively illiquid. That said, there are Limited Life and ‘Evergreen’ VCTs available which help investors manage a need for liquidity after the initial five year term.
Changes to tax legislation or the qualifying status of a VCT may affect the income and capital gains tax reliefs available.
5) What else should investors consider before exploring VCTs?
There are a wide range of VCTs available with different investment objectives, sector focus and growth targets and therefore guidance from a wealth manager or financial planner is recommended.
Investors should ensure that that they can accept the risk associated with an investment and that all basic investment allowances have been used.
Please do reach out if we can help at all.
Example case study: Helping an investment banking professional to invest their bonus through a VCT
Investment banking professionals may have a surplus income available each year, including a bonus. They are likely to have an existing investment portfolio and to have utilised their ISA, pension and capital gains tax allowances.
These clients may want to diversify their portfolio and invest in innovative companies with the aim of potentially gaining higher returns associated with high-risk asset classes.
As higher-rate tax payers, they may also be looking to benefit from appropriate tax reliefs.
A Venture Capital Trust allows individuals to invest in entrepreneurial companies. Investments of up to £200,000 per year generate an immediate tax relief of 30% (or a total of £60,000).
No tax is due on dividends and this means VCTs tend to provide relatively high yields for those seeking additional income. In addition, no tax is due on the capital gains resulting from the eventual sale of the asset.
If VCT investments are made regularly, the strategy can become self-funding once the first VCT investments begin to exit.
- Gross investment: £200,000
- Tax Relief received by the investor: £60,000
- Net Investment: £140,000
- Assumed dividend of 5% (based on gross share subscription): £10,000 tax free
- Tax-free yield: 7.14%
To generate the same return, an additional rate tax payer paying tax on dividends at rate of c. 40%, would need to obtain a yield of 11.9%.
A similar return calculation can be performed in relation to any long term capital gains, noting that the tax rebate itself can be invested or used as a contribution towards next year’s VCT subscription.
Please get in touch if you’d like to speak to one of our financial planners today.
It is advisable to seek independent financial advice from a tax specialist before making financial decisions. Tax treatment depends on the individual circumstances of each client and may be subject to change in future. All statements concerning tax treatment are based upon our understanding of current tax law and HMRC practice and can be subject to change.