In the run-up to tax year end, Sam McArthur speaks about the role alternative investments can play in an adviser’s tool kit.
Freezing thresholds spark tax-efficient thinking at financial year end
As the tax year approaches its end with annual allowances in focus, you may be wondering which alternative investments can help your clients who want to invest tax-efficiently. VCTs have evolved since they were launched in 1995 and are often now considered an interesting option for investors who have used their annual pension and ISA allowances. After ISA and pension allowances have been used, VCTs could be the next port of call for tax-efficient investments, although because of their higher level of risk VCTs should normally only form a small part of a diversified portfolio.
Once considered more of a niche investment, VCTs have steadily become more mainstream, particularly with investors who are concerned about tax increases. The Office for Budget Responsibility expects that the freeze on personal income tax bands until 2028 and rising wages will result in over 3 million taxpayers paying higher rate tax for the first time in the next five years and a further 400,000 moving into the additional rate tax bracket. Such an increase should naturally lead to a greater number of investors seeking tax-advantaged investment offers.
What exactly is a VCT?
A VCT is a company listed on the London Stock Exchange which invests in dynamic, entrepreneurial and fast-growing UK businesses. VCTs offer a route for investors to access private markets or certain companies listed on the Junior Market of the LSE, which can provide uncorrelated returns and diversification to investment portfolios.
Investors accessing VCTs must be comfortable with the higher risks associated with smaller companies. They are more prone to failure than established businesses and investors could get back less than they invest. The potential difficulties in selling VCT shares add an additional layer of risk. To compensate for the increased risk of investing in smaller companies, VCTs offer generous tax reliefs. A VCT needs to be held for a minimum of five years in order to maintain the tax incentives. The headline tax advantages include up to 30% income tax relief on your investment amount and tax-free dividends. The annual allowance for VCT investments is £200,000, so investors could claim up to £60,000 back from a year’s income tax bill. Much like an ISA allowance, this is a use it or lose it allowance which expires on the 5 April each year.
There is no capital gains tax to pay when you sell VCT shares but it should be noted that the majority of VCTs focus on paying a regular dividend. VCTs are therefore less suitable for an investor who has the sole aim of generating capital growth. Regular tax-free dividends are a common feature of VCT investing and if the performance of the VCT is very successful, it may also pay a special dividend. Regular tax-free dividends have previously aided clients with cashflow for annual expenditure such as school or university fees or for some in today’s higher interest rate environment, with repayments on mortgages.
How do investors get their capital back?
Given VCTs are listed, investors are able to sell their shares in the secondary market. VCTs also typically offer a share buyback facility for investors, provided the VCT has the cash available. Share buybacks are usually conducted at a 5% discount to Net Asset Value and are exercised at the VCT board’s discretion. The ability to exit VCT shares after the minimum five year holding period provides the opportunity to invest in a different VCT and benefit from the up-front tax relief again. If investors have more capital available, there is scope to continue to build VCT portfolio investments.
Broader market appeal and a scheme extension offer a positive outlook for VCTs
An exciting development within the VCT arena is their increasing accessibility as an investment option, with minimum investment amounts starting at £3,000. As VCTs have become a mainstay of an annual investment portfolio for those investors who are familiar with them, they are also a valuable part of an adviser’s business. Given the small minimum investment amount, advisers are finding VCTs are suitable for a broad range of clients and therefore VCTs have a positive impact on an adviser’s business.
Whilst extensive research is required to advise on VCTs, the time could be well spent this year. Chancellor Jeremy Hunt’s Autumn Statement included the extension of the VCT ‘sunset clause’ that underlined the government’s commitment to VCTs. The extension to 2035 demonstrates the government’s confidence in the ability of VCTs to provide capital to the UK’s innovative early-stage businesses and adds an extra layer of certainty for investors. Not only do VCTs offer access to a private asset class combined with tax incentives but they also offer an opportunity for advisers to expand clients’ annual investment portfolios and develop their business in the process. You have until 5 April to utilise some or all of your client’s annual VCT allowance, but don’t leave it to the last minute as capacity is limited.
What are the risks to consider?
However, investing in a VCT carries risk and you should take your own independent advice. You should only invest in Praetura Growth VCT on the basis of the prospectus which details the risks of the investment. Below are the key risks:
- Tax reliefs: Tax reliefs are not guaranteed, depend on individuals’ personal circumstances and a five-year minimum holding period, and may be subject to change.
- Liquidity: It is unlikely there will be a liquid market in the ordinary shares of Praetura Growth VCT and it may prove difficult for investors to realise their investment immediately or in full.
- Capital at risk: An investment in Praetura Growth VCT involves a high degree of risk. Investors’ capital may be at risk.
- General: Past performance of Praetura in relation to its offers is no indication of future results. The payment of dividends is not guaranteed. Investors have no direct right of action against Praetura. The Financial Ombudsman Service/the Financial Services Compensation Scheme are not available.
