Venture capital trusts: Leverage the HMRC to reduce your mortgage liability
Venture capital trusts (VCTs) have seen a meteoric rise in popularity since the UK government announced tax reliefs on money invested in these financial tools. Investing in VCTs could significantly boost your retirement planning, assist with school fees planning, or help you reduce your mortgage liability.
Keeping on top of your finances should always be a priority, but in practice this doesn’t always happen. Increases in the cost of living and mortgage rates, however, have underlined the urgency of ensuring you’re maximising your tax allowances and seeking the most efficient way to make your money grow.
As a result, alternative investments have increased in popularity as people look for returns higher than inflation, as they attempt to capitalise on the benefits such investments offer.
VCTs are a type of alternative investment that offer specific benefits. In this article, we will explain what they are, as well as the advantages and risks of investing in them.
VCTs in a nutshell
VCTs have been around for a while. The UK government introduced them in 1995 as part of a scheme to incentivise investment in a range of unquoted smaller trading companies.
Investment in VCTs has grown immensely since. According to UK government data, issued shares in 2021 to 2022 reached £1.12bn, a 68% increase from the 2020 to 2021 period.1
In year 2020 to 2021, VCT investors claimed Income Tax relief on £640m of investment, according to the same source.
The following list of questions provides a general overview of VCTs:
- What is a VCT? It’s an investment company owned by a fund manager, which raises funds for investments through new and/or top-up share issues to investors.
- What have VCTs been designed to do? With the introduction of VCTs, the UK government intended to encourage individuals to invest in unquoted (or AIM-listed), smaller trading companies. The aim is to get people to invest in these types of companies so they can have an active role in supporting economic growth.
- How do we actually invest in VCTs? Investors subscribe for shares in a VCT, then it’s up to the VCT to invest in the qualifying companies.
- Does that mean I become a shareholder of the companies I invest in? No, by investing in the VCT you become a shareholder of the VCT, not the companies in which the VCT invests.
- Are there any other tax-based venture capital schemes? Yes, similar schemes offering tax-related benefits include the Enterprise Investment Scheme and the Seed Enterprise Investment Scheme.
- Do I know any companies that have been VCT-backed? You might do. They include recipe kit box subscription service Gousto, jewellery brand Monica Vinader, or Virgin Wines.
Benefits of investing in VCTs
You should be aware that, just as with any financial instrument, there are risks associated with investing in VCTs. There is a section dedicated to understanding the risks further down this article.
But benefits first. As mentioned, the UK government wants people to invest in qualifying companies to boost the economy, so it has made VCTs an attractive proposition for investors. As an investor, a VCT offers a means of adding diversification to your portfolio.
From a tax perspective, investing in VCTs offers:
- Tax relief up to 30%
If you invest in VCTs, you should be able to claim tax relief at the rate of up to 30% up to the investment value of £200,000 per year. This means effectively you could claim up to £60,000 of tax relief annually, depending on how much you invest. Tax relief can be used to offset tax paid under income tax and dividend tax.
To be able to keep this benefit, you must ensure you hold your shares for at least five years.
- Dividends received are tax-free
Any dividends a VCT pays out will be free of tax, and there is no need to declare them on your tax return. In addition, the dividends received do not count towards an individual’s annual dividend allowance.
- Tax-free capital gains
Investments in VCTs are exempt from Capital Gains Tax (CGT). This means that, if you decide to sell your shares in a VCT (after the 5-year holding period), you won’t have to pay any CGT on these shares.
The risks of investing in VCTs
Of course, to reap all the benefits of investing in VCTs, you must be willing to accept the risks involved. As with any investments, you may not get back the full amount of capital you invested.
The downside of large growth potential is the high-risk nature of the investment. Investing via smaller companies carries higher risk and they can be more volatile than larger companies. At the same time, while smaller companies might carry more risk than larger counterparts, they might also offer higher growth potential and in some instances are less correlated to market events.
This means that VCTs should be seen as longer-term investments (which is also why the UK government encourages you to keep your shares for five years to retain your 30% tax relief); this may not be suitable for every investor.
It is worth pointing out liquidity across the VCT market is considered lower than in other markets. Consequently, selling your shares in a VCT could take longer than expected.
In addition, tax rules can change. It is entirely at the UK government’s discretion to change these benefits, like other tax allowances and exemptions.
What does this all mean in practice?
To illustrate one of possible outcomes of investing in VCTs, let’s consider a client scenario. This client told us she was looking for alternative options to be tax-efficient, having utilised her annual ISA subscription and pension allowance. In addition, the client was willing to accept a higher level of risk for the potential higher returns, without compromising future financial security.
This client is married, in her early 50s, and the couple has two children, aged seven and 12. She is a higher/additional rate taxpayer, and together with her partner they are paying a mortgage on their house, and their children’s school fees which are circa £50,000 a year.
Their current portfolio of assets undergoes the following requirements:
- Main residence value: £2m and paying mortgage
- Client saves regularly into an ISA, General Investments Account (GIA) and a Self-Invested Personal Pension (SIPP) annually, making sure she utilises tax benefits and exemptions.
The conversation began with an assessment of the client’s current portfolio position, her goals/objectives and attitude towards risk.
The client mentioned she has recently come off a favourable fixed-rate mortgage and would like to consider options for reducing this liability without compromising her family’s longer-term financial security.
After discussing several options, we agreed to increase our client’s risk profile marginally and redirect £100,000 from her GIA into a VCT. Performing this action involved redirecting funds, which meant that the client’s overall asset value position did not reduce, as it would have were she to, for example, pay a lump sum off the mortgage. By redirecting savings, we mitigated the risk of compromising the client’s longer-term financial security.
Given that VCTs allow for a 30% tax relief over the initial investment, the £100,000 investment into a VCT enabled the client to claim £30,000 back from HMRC.
Given that the client was considering her mortgage options, she used the £30,000 VCT tax relief to reduce this liability by making an overpayment.
The added advantage was that the £30,000 overpayment was within the annual 10% overpayment limit and did not result in mortgage penalty. Furthermore, reducing the capital owed on the mortgage reduced monthly mortgage servicing costs.
In summary, redirecting savings from a GIA into a VCT enabled the client to claim HMRC allowances back on this investment and reduce the burden of her current mortgage. With this solution, the client ended up executing an immediate solution to her mortgage concerns while improving her longer-term financial security.
It is worth noting the £30,000 tax relief could have also been used to assist with school fees planning.
To VCT or not to VCT?
We understand that VCTs might not be for everyone; every solution depends on our clients’ objectives and risk appetite.
The 7IM Private Client team has been working closely with clients for years, none of whom has the same goals or priorities. In the scenario above, where the client was happy to undertake a bit more risk, investing in VCTs provided the optimal solution, helping them achieve their long-term financial goals.
But every client is different. While some might want to reduce their mortgage liability or decrease the burden from paying their children’s school fees, or simply to ensure they meet their income goals at retirement – our approach is always the same.
We listen to the client’s needs, and we work and execute a plan that targets their goals.