Archived article: This article was correct at the time of publishing. Tax, investments and pension rules can change over time so the information below may not be current.

VCTs: tax-efficient investment into smaller companies

In recent years the number of people who have been drawn into the higher rates of Income Tax has crept up steadily. But with the UK budget deficit remaining unconquered and with a potential change of Government this May, cuts to the higher rates of tax seem a distant prospect and rates could potentially increase for the highest earners.

Jason Hollands Jason Hollands
06 February 2015

With that in mind, it is unsurprising that core tax-efficient allowances such as ISAs and pensions play a central role in our clients’ long-term investment plans. While the ISA allowance has had a welcome increase this year to £15,000 per adult, when it comes to pensions the maximum gross amount investors can contribute annually was reduced in 2014 from £50,000 to £40,000.

For those investors who are subject to the higher rates of tax and who are already fully-utilising core allowances such as ISAs and pensions but have additional cash to invest for the long-term, Venture Capital Trusts (VCTs) can be an additional part of the tax-efficient investment toolkit worth considering. These are specialist investment schemes that invest in portfolios of unquoted or AIM-listed UK smaller companies. To incentivise investors for the inherently higher risk involved, the Government provides VCT investors with a number of tax reliefs.

Firstly, investment in a VCT new share issue attracts a 30% Income Tax credit – which is claimed through the investor’s annual self-assessment tax return. The investor must have paid the equivalent amount of tax being reclaimed, and importantly, they must then hold the VCT shares for at least five years or they will be required to repay the tax relief.  The maximum amount a UK resident tax-payer can invest in VCTs this tax year is £200,000, potentially providing an Income Tax credit of up to £60,000.

Once invested in a VCT, investors will receive any dividends free of tax and they do not need to disclose VCT income on a tax return. Furthermore, any gains made on VCT shares when sold are exempt from capital gains tax. The dividend yields on mature VCTs can be high, but are not guaranteed, and because they are tax-free they can be especially attractive to those subject to the higher rates of tax and who are comfortable with the risks involved.

Selecting the right VCTs is key

It is important to understand that “there is no such thing as a free lunch”. The Government provides VCT tax incentives for a reason: smaller companies are seen as the backbone of the UK economy and since 1995 both Conservative and Labour governments have seen VCTs as a key component of policies designed to support smaller enterprises. Unquoted and AIM-listed companies are however illiquid and therefore VCTs should be regarded as higher-risk investments. Each VCT will have its own approach to managing risk and it is therefore important to select VCTs carefully. This year, there are over 20 offers to choose from.

We have been researching VCTs since their inception in 1995 and are widely recognised as a leading specialist in this area. We conduct detailed due diligence including face-to-face meetings with the management teams before publishing our reviews and ratings for each offer. Additionally, we are able to cut the costs of investing in VCT share offers through the great discounts we have negotiated with the VCT groups.

To find out more about VCTs, their rules and how they work, download our free guide. For information on current offers open for investment including our reviews, click here.

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The value of investments, and the income derived from them, can go down as well as up and you can get back less than you originally invested. This article does not constitute personal advice. If you are in doubt as to the suitability of an investment please contact one of our advisers.

VCTs should be regarded as higher risk investments. They are only suitable for UK resident taxpayers who can tolerate higher risk and have a time horizon of greater than five years. Past performance is not an indication of future performance. Owing to the nature of their underlying assets, VCTs are highly illiquid. Investors should be aware that they may have difficulty, or be unable to realise their shares at levels close to that that reflect the value of the underlying assets. Tax levels and reliefs may change and the availability of tax reliefs will depend on individual circumstances. You should only subscribe for new VCT shares on the basis of the relevant prospectus and must carefully consider the risk warnings contained in that prospectus.