Are your clients making the most of VCTs?

In a moment we’ll look at some client scenarios in which a VCT investment could form part of the planning. Before that, let’s take a few moments to look at what VCTs are and how they work.

A quick refresher on VCT tax reliefs

The government created VCTs in 1995 They enable investors to claim certain tax reliefs, which act as an incentive to invest in high-risk, high growth potential early-stage businesses. Under the current rules, a VCT investor can claim upfront income tax relief equivalent to 30% of their VCT investment on investments up to £200,000 per tax year. Capital gains and dividends are also tax free.

As you’ll see in a moment, the fact that investors can claim upfront income tax relief makes VCTs a useful planning tool in a variety of scenarios. However, it’s important that clients are fully aware of the risks, as this type of investment won’t be suitable for everyone.

What are the risks?

VCTs invest in smaller, less established companies. 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.

Clients should also be aware that the share prices of VCTs may be more volatile than other shares listed on the main market of the London Stock Exchange. They can also be harder to sell.

Also bear in mind that tax treatment depends on individual circumstances, and tax rules could change in the future. Tax reliefs also depend on the VCT maintaining its qualifying status.  Clients will also need to hold a VCT investment for five years, or otherwise pay back any upfront income tax relief claimed.

Client situations in which a VCT may help

Restrictions on pension contributions have left many clients looking for additional tax-efficient ways to invest towards their retirement. While it’s true that fewer clients will be affected by the annual allowance after the threshold and adjusted income limits were raised this year, those that are face a lower tapered annual allowance.

Of relevance to more clients is the lifetime allowance, which appears to have been a motivation behind a lot of VCT cases in recent years. This rose to £1,073,100 this year, the lowest level to which the government could have increased it under current rules. The lifetime allowance remains a material constraint on tax-efficient pension saving for a lot of people. And of course, high earners who take advantage of any increase in their annual allowance can expect to find themselves butting up against the lifetime allowance sooner than they otherwise would have.

Clients will typically be in their accumulation phase for twenty to thirty years. High-earning clients could spend around half of this period making enough in income to use up their pension and ISA allowances, or worried about exceeding the lifetime allowance. 

That’s ten to fifteen years during which such clients could benefit from making regular VCT investments, which represent another tax-efficient way to invest for retirement. Multiply that by the growing number of clients affected by the lifetime allowance, and you can see why it’s worth the time researching VCTs so that your firm is in a position to recommend them to clients who could benefit.

VCTs can also be a useful planning tool for clients who own a business. The rules on dividend taxation mean entrepreneurs who pay themselves through dividends could face higher tax bills if they want to increase the dividend they pay themselves. Investing in a VCT could be a way to offset these costs, and therefore help clients extract money from a business tax efficiently.

Clients who are landlords may also benefit from investing in a VCT. Recent rule changes, such as the removal of mortgage interest tax relief, have made it more important for landlords to consider the tax implications of investment properties. For some landlords, a VCT investment may be a good way to offset some of the tax they pay on their rental income.

Identifying clients who could benefit from tax-efficient investments

Tune in to the Octopus Online Show on Thursday 5 November at 10am for a tax planning special.

We’ll be looking at areas of opportunity in advisers’ client banks and how tax-efficient investments can help clients in a variety of situations.

You’ll also hear from other financial advisers about the role these types of investments pay in their own clients’ planning.

For more information, and to reserve your place, go to octopusinvestments.com/estate-planning-show-episode-5/.

Jessica Franks, Head of Tax

*Tax Efficient Review, April 2020. 

VCTs are not suitable for everyone. Any recommendation should be based on a holistic review of your client's financial situation, objectives and needs. We do not offer investment or tax advice. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. We record telephone calls. Issued: October 2020. CAM010117-A.