There’s good reason to expect demand for Venture Capital Trusts (VCTs) to be high this year. Fundraise capacities are limited and we’ve seen some of our VCTs fill in a matter of weeks in the past. So it makes sense to be proactive for VCT season to avoid disappointed clients and missed opportunities.
If you’re in any doubt about making VCTs a priority for your clients, here are three reasons you should be on the front foot.
1.Key drivers of demand haven’t gone away
The amount of income tax paid has doubled in the last 20 years. This includes an additional 440,000 additional rate taxpayers in 2021-22 alone. With the higher-rate tax threshold frozen until at least 2026, the number of higher-rate taxpayers is set to grow further. Advisers will want to make sure their clients are making full use of their available tax allowances. For suitable clients, that might mean considering a VCT.
VCTs are pooled investments which incentivise investors to support early-stage companies by offering a range of tax benefits. They have become more popular with advisers to complement a client’s wider investment portfolio. What’s more, they offer attractive tax reliefs on investments up to £200,000 each year.
VCT investors can claim up to 30% upfront income tax relief, provided they hold the investment for five years. And there’s no tax to pay on any dividends received, meaning investors can target a tax-free income stream. These tax reliefs exist to compensate investors for some of the additional risk they take by investing in small companies. Therefore, where a client has built up significant pension and ISA investments, and has an income tax liability, a VCT can be an additional way to invest tax-efficiently.
It’s a similar story with another important driver for VCT investments, the annual pension allowance. This limits the amount an investor can put into their pension on a yearly basis. For most people it sits at £40,000, but for higher earners, earning over £240,000 it can be reduced to £10,000 and in some cases tapered even further down to £4,000. The latest data available from HMRC shows the numbers breaching their annual allowance is trending upwards, up 15% year on year in 2018-19.
Another pension cap to worry about is the lifetime allowance (LTA), which is a cap on the tax-privileged pension funds a client can build up over their lifetime. HMRC have seen an uptick of 6% between 2018-2019 on the tax paid by those exceeding this allowance. This allowance is also frozen at current levels until at least 2026.
Once a client expects to hit or exceed their annual or lifetime allowances, a VCT can become an attractive way to complement their investments. It’s an investment that can be accessed, subject to liquidity, ahead of a pension. And it offers the possibility of tax-free income.
2.You might have new planning opportunities to explore
These are the common scenarios we see, but other tax squeezes have driven advisers to identify clients in other situations where a VCT can help.
Take clients who own a business. Given the changes to dividend taxation in recent years, the effective rate at which dividends are taxed has increased for most, and that means that business owners who pay themselves through dividends could face higher tax bills and lower take-home earnings. VCTs could be a way to offset these costs and help to extract money from a business tax efficiently.
Elsewhere, some clients who own rental properties and want to invest for the future have turned to VCTs. Until 2017, buy-to-let landlords could deduct their mortgage interest from their rental income and only pay tax on the net income. Today, landlords can now only receive a tax credit equivalent to the basic rate of tax. Higher or additional-rate taxpayers won’t get all the tax back on mortgage interest payments. VCTs offer landlords a way to invest their rental income tax-efficiently. This is especially powerful because entitlement to make pension contributions requires ‘relevant earnings’, typically from employment, that many landlords will not have.
3.Now is an exciting time for venture capital
Many clients have experienced increased propensity to invest during the pandemic, when disruption has created opportunities and new markets for early-stage companies to address. Naturally, there’s been a huge amount of interest from investors in smaller company investing.
Through the investment managers, VCTs provide access to companies that retail investors wouldn’t otherwise have access to. As they typically invest in smaller companies, either unquoted or not listed on a main market, which are early in their journey, there’s significant opportunity for growth. Whilst these companies carry a higher risk profile, they can be flexible and adapt quickly to shocks, such as a global pandemic. Compared to larger companies, they are often more able to turn the ship quicker and exploit new opportunities.
As pooled investments, VCTs also provide diversification within the portfolio. Not only do they back a range of types of companies across different sectors, but they also provide access to companies at various levels of maturity – some older companies may have been held in the VCT for a number of years, and some will naturally be very early stage.
Unquoted companies are also less likely to be affected by market sentiment, as their shares aren’t traded on a main stock exchange. Instead, their share prices are calculated periodically, based on the underlying performance of the business rather than the emotions of the herd. We’re certainly seeing fantastic opportunities for these kinds of companies.
It is, however, important that any client understands the risks before they decide to invest. VCT shares are high risk, their share price may be volatile and they may be hard to sell. The value of a VCT investment, and any income from it, can fall as well as rise, and investors may not get back the full amount they invest.
Tax treatment depends on individual circumstances and may change in the future. Tax reliefs depend on the VCT maintaining its VCT-qualifying status.
Clients will also need to be comfortable with holding the shares for at least five years in order to keep any income tax relief they claimed.
Written by Matt Jackson DipFA, IFA & Director at Beesure Ltd