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Venture Capital Trusts – Attractive Tax Relief…But Watch the Investment

Venture Capital Trusts – Attractive Tax Relief…But Watch the Investment
Malcolm Finney advises Investors to always approach investments with caution where the associated tax reliefs appear to be overly attractive, none more so than with respect to the VCT. As the saying goes “If it looks too good to be true...”

 

Introduced in 1995, VCTs have perhaps in the event not proved quite the solid investment as some might have suggested but the attractive tax reliefs have at least ameliorated any damage.

 

What are VCTs?

VCTs are simply quoted companies which are required to invest a proportion of their funds into unquoted companies; the investments undertaken must, however, take the form of new subscriptions and not simply purchases in the market place (as the objective of VCTs is to secure funds for companies which otherwise have limited access to new capital).

 

Not all quoted companies are eligible for VCT investment including companies involved in property development, land dealing, farming, hotels, care homes and the provision of financial, accounting or legal services.

 

For an individual investor to obtain the tax reliefs below he/she must be at least 18, although residency in the UK is not a requirement (compare the ISA).

 

Income Tax Relief

A 30% rate of tax relief is available to an individual investor for investments up to £200,000 per tax year. This 30% rate is fixed irrespective of the taxpayer’s marginal rate of income tax (be that 20% or 40%). The net cost to the individual investor is thus 70% of the gross investment.

 

The manner in which the relief is granted is straightforward, namely, the amount of tax relief (e.g. 30% of £200,000 = £60,000) is simply deducted from the taxpayer’s income tax payable for the tax year. On these figures it becomes clear that to obtain full tax relief on the maximum investment requires the taxpayer to be exposed to an otherwise significant tax liability for the tax year.

 

Dividend income arising on the investment is exempt from income tax. The investor must, however, maintain the investment for a minimum period of five years if no part of the relief is to be withdrawn, and dividends thereon are to be tax exempt; VCTs are not therefore a short term investment.

 

Carry-back Option

One reasonably attractive feature of the VCT is the ability of an investor to carry back for use in the immediately preceding tax year some part or all of the tax relief available. This permits an investor to ascertain his/her income tax liability for, say, the tax year 2009/10 and, depending upon the amount of tax relief sought, invest the appropriate amount in 2010/11 with the attached tax relief being used to reduce the tax payable for 2009/10 (thus preventing any unusable tax relief from occurring) subject to not exceeding the maximum relief in a tax year of 30% of £200,000.

 

Capital Gains Tax Relief

No capital gains tax charge arises on disposal of the investment irrespective of the length of time the investment has been held but the quid pro quo is that any capital loss arising on disposal is not an allowable (i.e. offsettable) loss for capital gains tax purposes.

 

Inheritance Tax

There are no particular reliefs with respect to inheritance tax.

 

Practical Tip

If the 5 year horizon and risks are acceptable to an investor, the 30% income tax relief, combined with exempt capital gains on disposal, makes the VCT a highly “tax-attractive” vehicle. A gross investment of 100 growing at 5% compound per annum produces a net of tax return after 5 years of 39.46% equivalent to 65.76% to a 40% taxpayer (or possibly 0% if the VCT goes under!).


Malcolm Finney