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5 ways to use VCTs in financial planning

1 February 2019

Venture capital trusts (VCTs) can benefit clients in a broad range of different situations, says Paul Latham, managing director, Octopus Investments.

Over the course of the 2017-18 tax year, more than 400 advisers wrote their first venture capital trust (VCT) case with Octopus.

It was indicative of the wider trend towards making more use of VCTs. Indeed, more advisers are looking at VCTs for clients who, not so long ago, they probably wouldn’t have.

Paraplanners who understand the reasons behind this trend will be in a strong position to take advantage of it. This article looks at why the range of clients who could benefit from VCTs has broadened in recent years, and presents 5 client scenarios to look out for.

First, a quick recap on VCTs

VCTs are a powerful planning tool because they offer investors attractive tax reliefs on investments up to £200,000 each year.

Investors can claim upfront income tax relief worth up to 30% of the amount they invest, on the proviso that they then hold the investment for five years. There’s also no tax on dividends or capital gains.

The Government supports these tax reliefs because they give investors an incentive to take on the risks of backing early stage companies. So clients need to be comfortable putting their capital at risk in this way, and understand that they may not get back the full amount they put in.

5 ways to use VCTs in financial planning

1. As alternative to pension contribution caps

A major driver of VCT demand remains constraints on pension contributions. The annual allowance restricts the amount investors can put into a pension each year, meaning some high earners are looking for alternative, tax-efficient ways to invest for retirement.

At the same time, the lifetime allowance (LTA) means investors are wary of seeing their pension pots grow beyond £1 million, for fear of incurring additional tax charges. This too creates an incentive to find alternative tax-efficient investments.

The Government has cut both of these allowances in recent years. Last year, HMRC released figures showing the total tax paid by those exceeding their allowances. The figures show that tax paid as a result of people exceeding the LTA rose from £5 million in 2006-07 to £102 million in 2016-17.

Over the same period, total tax paid by as a result of people exceeding their annual allowance rose from £2 million to £561 million.

Clearly there is an incentive for high earners and those with large pension pots to find other tax-efficient ways to plan for retirement. For some, a VCT fits the bill.

VCTs can help clients in other situations too, for example:

2. Landlords squeezed by recent tax changes: Until 2017, buy-to-let landlords could deduct their mortgage payments from their rental income for tax purposes. The government is now phasing out this relief. From April 2020, landlords will only receive a tax credit, which will refund at the basic rate of tax. So higher and additional-rate taxpayers won’t get as much relief as they previously did. For buy-to-let landlords who make a lot of their income from their property portfolio, VCTs can offer a way of accessing upfront income tax relief.

3. Business owners who want to access the cash in their business: Recent changes to dividend taxation mean entrepreneurs who pay themselves through dividends could face higher tax bills and lower take-home earnings. VCTs can be a way to offset these costs and help clients extract money from a business tax efficiently.

4. Clients with a significant income tax liability: Clients can claim up to 30% upfront income tax relief on investments up to £200,000 each year. That means they could save as much as £60,000 on their tax bill, provided they hold the shares for five years and are comfortable with the risks of investing in VCTs (see below).

5. Clients looking to diversify their investment portfolio: VCTs offer the opportunity to invest in a portfolio of early stage companies, which offer the potential for high returns over a time period of five years or more.

VCT risks clients should keep in mind

There are of course risks involved. Just because a client has one of these planning problems doesn’t automatically mean a VCT is the right choice.

VCTs invest in smaller, less established companies, and this type of investing won’t fit with the risk profile for many investors. 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 invested.

As well as the risk of loss, clients should be aware that the share prices of VCTs can move around more than other companies you’ll find listed on the London Stock Exchange’s main market. They can also be harder to sell.

Clients should also remember that tax treatment depends on individual circumstances, and tax rules could change in the future. Tax reliefs also depend on the VCT maintaining its VCT-qualifying status.

VCTs can benefit a diverse range of clients. The key is spotting those clients who could benefit and who are comfortable with the risks, and then starting that conversation with them.

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