The last year was tough for investors. Market uncertainty cause by the War in Ukraine, an inflation-driven cost-of-living crisis and the throes of recession made the hunt for investment returns that bit harder.
Coupled with government changes to income tax thresholds and the taxation of dividends have – should you find the right investments – it became harder to get bang for your buck.
VCTs might be the stone that kills both of these birds, as Ewan MacKinnon, partner at Maven Capital Partners explains. He says VCTs should play a bigger role in helping investors create a tax-efficient portfolio. MacKinnon writes…
With 2023 marked by continued economic uncertainty, investors have an eye on macroeconomic factors, where the impact of Russia’s invasion of Ukraine as well as the longer terms ramifications of the Covid pandemic, have resulted in volatile investment conditions for both public and private markets.
While the Bank of England and the Office for National Statistics (ONS) have indicated that inflation levels may have peaked late last year, there isn’t expected to be a dramatic fall in 2023, and increased taxes are likely to further place pressure on investment returns. So, for investors looking to protect the value of their savings and pension portfolios, nearly a quarter of investors have placed tax planning as a top focus for this year, according to a recent survey.
With an impressive record of returns, VCTs offer an attractive tax-free investment option and are likely to play a larger role for investors looking to maximise their tax reliefs in 2023 and beyond.
Tackling Tax-Rises
The decision by the government in last year’s Autumn Budget to reduce income tax thresholds and tax-free allowances on dividends may not have taken investors by surprise, but it has left many looking for ways to mitigate the impact of those changes. However, VCTs provide a valuable opportunity for investors to combat the impact of both tax and investment factors.
UK taxpayers are allowed to invest up to GBP200,000 a year in VCTs and receive 30% initial income tax relief (for example GBP30,000 initial relief on an investment of GBP100,000, reducing the effective cost of the investment to just GBP70,000). In addition, any dividends paid by the VCT are tax-free and investors are exempt from capital gains tax when they sell their VCT shares.
Furthermore, VCTs as an asset class have proven themselves as an increasingly valuable element of a diversified portfolio. Offering access to carefully researched investments in unlisted companies sourced by specialist investment managers, which would otherwise be difficult to access for most investors, VCTs have performed impressively over the last decade.
As VCTs provide returns largely in the form of dividends, underpinned by profitable portfolio realisations, this can be an extremely tax-efficient means of generating value for shareholders and allows VCTs to target a regular tax-free dividend income.
Prudent Pension Planning
Many advisers and their clients also now view VCTs as a tax-efficient way to complement their retirement planning as, in addition to VCT investments offering initial tax relief and the potential to generate a steady tax-free income stream, they are not subject to a lifetime limit.
Substantial reductions to the annual and lifetime pension allowances in recent years have had a significant impact on the ability of high earners to fund their pensions, with the threat of significant penalties for exceeding these limits.
However, VCT investments are subject only to an annual limit of GBP200,000 on which investors can claim initial tax relief, so can offer an attractive option for investors who are comfortable with the risk and asset profile of VCTs, as they offer the potential for boosting pension planning but without falling foul of pension contribution limits.
Backing British Businesses
However, VCTs offer investors more than just attractive tax benefits, as they also provide exposure to professionally vetted, ambitious smaller companies selected by expert managers for their high growth potential. Despite the economic turbulence of recent times, the total number of disruptive, high-growth start-ups has continued to rise according to a recent survey, and the opportunity is ripe for investors to fuel innovation across the nation.
Since 2018, VCTs have made over 1,000 investments in 530 companies across the UK. These companies have employed a total of 14,042 staff, with nearly 80% of businesses backed by VCTs since 2018 investing an average of GBP2.8m in research and development, according to the Association of Investment Companies.
Ultimately, VCTs present investors with access to young and dynamic UK businesses, helping to diversify their investment portfolio and spread investment risk, whilst also maximising tax reliefs.
