Diana French, Retail Strategy Director at Triple Point, explains how the tax benefits available through a VCT can be particularly helpful for business-owning clients who want to minimise their tax footprint.
There’s nothing quite like the end of the tax year to focus the minds of business owners. And with an ever-changing tax landscape to contend with, extracting profits from their business without triggering an unwelcome personal tax bill remains one of the biggest challenges most business owners face.
It’s a widely accepted practice for limited company owners to pay themselves a salary up to the tax-free personal allowance and then top up the rest of their income with dividends. But this approach is less effective than it once was. When the Dividend Allowance was introduced in 2016, the first £5,000 of annual dividend income received was tax-free. However, this allowance was lowered to £2,000 in the 2018/2019 tax year and cut again to £1,000 in the 2023/2024 tax year. The Dividend Allowance is being halved yet again for 2024/25, meaning only the first £500 of dividend income received will be free from tax.
So, despite being able to choose how they get paid, for most small business owners, taking a decent income out of a small business as tax-efficiently as possible has only grown more challenging with each passing year. Now more than ever, many business-owning clients need help in finding ways to boost their income, reduce their personal tax bill and make life that little bit easier.
Client planning example
Let’s consider a typical scenario of a business-owning client. Raj is a design consultant with his own limited company. To be tax-efficient, he pays himself a salary up to the tax-free personal allowance of £12,570 and tops up his income with an annual dividend of £50,000. However, he is aware that his tax bill resulting from this annual dividend is less than ideal.
At present, Raj can claim a £1,000 tax-free allowance on the dividend he paid himself in the current tax year. The next £36,700 is taxed at 8.75%, and the remaining £12,300 is taxed at 33.75%. This leaves Raj with an income tax bill of £7,363. It means that withdrawing £62,570 from his limited company annually leaves him with just £55,207 after tax.Raj discusses his situation with his financial adviser, who discusses the benefits and the risks of investing in a Venture Capital Trust (VCT). His adviser tells Raj that if he invested £24,543 in a VCT, he could claim 30% income tax relief on his investment, which equates to £7,363, provided those VCT shares are held for the minimum five-year holding period.
VCTs often target a free dividend, so Raj can expect to receive an annual tax-free income from his investment. VCT dividends are completely tax-free, and there’s no requirement for Raj to declare them on his tax returns. As a result of his investment, Raj effectively wipes out his income tax liability, giving him an annual income of £62,570 plus the potential for tax-free dividends from his VCT investment.
A significant advice opportunity
Given there are 5.51 million small businesses (with 0 to 49 employees) operating in the UK, representing 99.2% of the total UK business population[1], this clearly represents an enormous financial planning opportunity for advisers to tap into. Importantly, when it comes to recommending VCTs to business owners, the job of bringing these investments to life for some of the highest-value clients is relatively straightforward.
In our experience, business owners are often very willing to consider investing in a VCT because when it comes to the challenges that smaller companies face, and the thin lines between success and failure, they instinctively ‘get it’. Business owners know better than anyone why smaller businesses need access to capital, and investing in VCTs means they get to support the UK’s entrepreneurial ecosystem and do their bit in funding their success.
Of course, helping business owners to withdraw profits from the business tax-efficiently is just one example of how a VCT can solve different clients’ financial planning challenges. And, with Consumer Duty placing an increased emphasis on delivering good outcomes for consumers, the tax benefits available through VCTs make them an increasingly essential tool in the advisers’ toolkit.
