VCTs boom ahead of dividend tax increases

One of the effects of the impending increase to personal taxes has been fresh interest in VCTs (venture capital trusts).

Part of the government’s post-Covid, phased tax raising policy includes an increase to dividend taxes, which have already been increased in recent years. This is one of the outcomes of the new health and social care levy and has made VCTs look more attractive as a tax efficient investment for less risk averse investors. A further influencing factor is the restriction to pension investments for additional rate taxpayers.

Tax breaks on additional income

VCTs offer taxpayers a chance to invest in relatively risky, early-stage British companies. In doing so, they can benefit from generous income tax relief and shelter chargeable gains from tax. Unlike ISAs which provide a tax efficient shelter for income and gains arising from the investment, EIS and VCT investments reduce income tax, and potentially capital gains tax liabilities at the time of investment. All are useful for additional rate taxpayers, for example, if you have an income tax liability of £30,000 this can potentially be reduced to zero if you have the means to invest sufficient funds into an EIS or VCT.

Clearly this is not appropriate for every taxpayer, but there is a growing number for whom it is relevant, and the figure seems to be rising fast. Since 6 April 2021 when the new tax year began, VCTs have raised £128m, which according to research conducted by Wealth Club, is the fastest growth seen since 2006 and five times more than in the same period last year.

How do VCTs save tax?

Provided the VCT assets (i.e., shares in a VCT fund or HMRC approved VCT company) are held for 5 years, investors can claim and retain income tax relief of 30% at the time of investment, and there will also be no capital gains tax payable on disposal. Importantly, all dividends received are tax free and this potential income that would otherwise be subjected to the new dividend tax.

Starting from April 2022, the tax payable on dividends above £2,000 will increase by 1.25% to 8.75%, 33.75% or 39.35%, depending on the levels of other income of the recipient. As an example, an additional rate taxpayer earning more than £150,000 will pay tax of £7,870 on the first £20,000 of any taxable dividend income on which they are currently paying £7,620.

Our recent blog explains exactly how taxes will increase due to the health and social care levy and what to expect: https://rjp.co.uk/business-owners-will-face-triple-tax-rise-from-health-and-social-care-levy/.

Things to consider with VCTs

If you are considering alternative investment options that are more tax efficient, bear in mind that the profile of VCT eligible companies has changed in recent years. The government now favours VCTs focused on younger companies, which may be less stable and could increase the risk of losing your original investment; specialist investment advice should always be taken before investing.

Typically, VCTs and EIS investments should only be considered once taxpayers have explored all the other tax efficient options first – ISAs, pensions, gifting and potentially salary sacrifice schemes if relevant.

If you would like tax planning advice contact partners@rjp.co.uk.