Business owners and landlords
Business owning clients are often facing higher income tax bills than in previous years when they extract profits by dividend.
Changes to dividend taxation in recent years have increased the effective rate at which dividends are taxed for most individuals. As a result, business owners who pay themselves through dividends could face higher tax bills and lower take-home income.
VCTs could be a way to offset these costs and help extract money from a business in a tax efficient manner, as well as offering a route into potential investment growth.
In a similar manner, buy-to-let landlords have experienced reductions in tax relief in recent years. Clients who own rental properties can no longer deduct their mortgage interest from their rental income and pay tax on the net income. Instead, a tax credit is provided, but as this is only equivalent to the basic rate of tax, higher or additional-rate taxpayers won’t get all the tax back.
For landlords who want to invest for the future, VCTs offer a way to extract and invest rental income tax-efficiently. VCTs can also be a useful way to invest for the long term for landlords as entitlement to make pension contributions requires ‘relevant earnings’, typically from employment that many landlords will not have.
Experienced investors
Many clients that have a broad investment portfolio and high annual income could benefit from an opportunity to invest in smaller companies.
The exciting growth potential and diversification that early-stage smaller UK companies can offer can be extremely appealing for investors in this sector. VCTs offer a route to access this, because they invest in companies that are either unquoted or not listed on a main market, which many clients won’t have much exposure to in their existing portfolio.
Smaller companies that are invested in through VCTs can be flexible and adapt quickly to shocks, such as the recent global pandemic. Compared to larger companies, they are often able to turn the ship quicker and exploit new opportunities.
Unquoted companies are also less likely to be affected by market sentiment, as their shares aren’t traded on a main stock exchange. Instead, their share prices are calculated periodically, based on the underlying performance of the business.
High growth but high risk
Like any investment, a VCT will not be right for everyone, even if the client does fit into one of the sectors mentioned above. For those that do appear to suit, it is important to make clear the risks as well as the benefits.
VCT shares are by their nature high risk, their share price may be volatile and they may be hard to sell. 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.
Tax treatment depends on individual circumstances and may change in the future, and tax reliefs depend on the VCT maintaining its VCT-qualifying status.
However, if these risks are considered and the investment is part of a well-balanced portfolio, the potential benefits can be great for more individuals than you might think.
Paul Latham is Managing Director of Octopus Investments
