Tax Year-End: VCTs and tax mitigation

Where an investor is more adventurous and interested in the significant tax rebates available from HMRC, I favour Venture Capital Trusts (VCTs) over Enterprise Investment Schemes (EIS).

They are both higher risk than typical equity -based funds as they invest in smaller, relatively new companies. Simply put, a VCT is an investment trust comprising a number of different investments, and an EIS is typically just a single investment. It’s an eggs and baskets thing for me – an EIS requires a greater leap of faith.

The tax breaks on VCTs are significant. Provided they are held for the qualifying term (5 years) they offer 30% tax rebate based on the amount you invest (invest £100k, get £30k reduction on your current year’s tax bill – but you must have incurred that much income tax in that tax year in order to benefit) – and all income streams – dividends and capital gains, are tax free.

Innovative providers of VCTs have designed “lower risk” limited life offerings which are designed to liquidate after the qualifying period is up (in practice this is around a 6 year cycle). They invest mainly in asset-backed businesses (e.g. those with significant real estate) and/or those with predictable income streams. Staying within the rules, they  offer fairly modest gross returns whilst mitigating risk as far as they can. When added to the 30% initial tax saving, the IRR on such investments might for example be 7% to 9% for a higher rate taxpayer. After liquidation, the funds can be re-invested again and obtain a further tax rebates. Limited Life VCTs also avoid the criticism levied against traditional VCTs – where encashment is nearly always at a discount price compared to net asset value. A limited life VCT liquidates, so the investor receives full NAV.

But for those who like to buy and hold, then “Evergreen” VCTs can offer more risky but often more rewarding returns, with no tax on the income streams from year to year.

There is a VCT “season which commences in December each year and carries on past the tax year-end, offering investment in one or both tax years for a particular offering. Up to £200,000 per tax year means a maximum of £400k can be invested across the tax year-end. Minimum investments are usually £5,000 to £10,000.

If you would like to hear more about VCTs, please contact me.

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