VCT guide

11 10 RISKS AND REWARDS RISKS AND REWARDS Income tax relief VCT investors are potentially able to claim a reduction in their income tax bill of 30% of the cost of the VCT shares they have purchased, up to the permitted maximum of £200,000 worth of shares in any tax year. The reduction is applied to the investor’s income tax bill in the same tax year as the shares are issued. However, unlike EIS, there is no carry back of a VCT subscription to a previous year. Example A client who purchased the maximum £200,000 of VCT shares would be entitled to claim up to £60,000 of income tax relief (£200,000 x 30%). If the client only paid £30,000 of income tax , £30,000 of that potential relief would be lost (£60,000 - £30,000). Leftover income tax relief cannot be carried back or forward. In this case the client could have invested £100,000 in VCT shares and still have reduced their income tax bill to zero. Example A client subscribes for £100,000 of VCT shares and receives £30,000 income tax relief. If the client was to then sell those shares for £150,000 within five years, HMRC would claw back the full £30,000. The only cases when it might make sense to sell shares within the five-year period, are when the sale proceeds exceed any clawback of income tax relief. Example Assume a client buys £100,000 of VCT shares and receives £30,000 income tax relief. If the client was to then sell those shares for £34,000 within five years, HMRC would claw back £10,200 (£34,000 x 30%). Example Assume a client buys 100,000 VCT shares for £100,000 and receives £30,000 income tax relief. If the client then sold 10,000 of those shares for £2,000 within five years, the clawback would be the smaller of: • the relief given on shares disposed of (£30,000 x 10,000 / 100,000 = £3,000 in this example). • the consideration received x 30% (£2,000 x 30% = £600 in this example). In this example the relief to be withdrawn is therefore £600. If shares are disposed of other than at arm’s length (a normal commercial transaction between two or more persons that does not favour one or other of the parties i.e. there is no collusion between the buyer and the seller) all the relief given in respect of the shares disposed of is withdrawn. Clawbacks The clawback can never be more than the amount of the initial income tax relief (subject to any interest that may be due). If the shares are disposed of at a gain within five years, HMRC will claw back the full amount of the tax relief received. HMRC will claw back income tax relief by raising a special assessment for the tax year in which the relief was obtained. Transferring the shares to a spouse or civil partner within the five-year period does NOT trigger a clawback of income tax relief, but transferring the shares to any other third party does. There is no clawback if the disposal or transfer is a result of the investor’s death. Brand new shares To qualify for income tax relief the client must subscribe, pay for and be issued brand new shares in a VCT. Secondary purchases, either purchased on an exchange or arranged privately, do not qualify for income tax relief. Tax-free dividends Dividends issued by VCTs are exempt from income tax and investors who receive exempt dividends do not have to show them on their tax returns. There is no minimum holding period for this relief, and it applies to both subscriptions for newly-issued shares and purchases of shares in the secondary market. However, the exemption from income tax on dividends is subject to the permitted maximum. Example A client with a £250,000 portfolio of VCTs that yielded 5% would be entitled to £12,500 tax-free income annually (provided that no more than £200,000 of VCT shares had been purchased in any single tax year). Tax-free growth (disposal relief) Disposals of VCT shares are not subject to CGT as long as the company was a VCT both when the investor acquired the shares and when he or she disposed of them, and they are aged 18 or over at the date of disposal. There is no minimum holding period for this relief, and it applies to both subscriptions for newly- issued shares and purchases of shares on the secondary market. However, disposal relief is subject to the permitted maximum. Example A client purchases £50,000 of VCT shares and then sells them for £75,000 six years later. Conventional shares would have attracted £5,000 CGT (ignoring any annual allowances and applying the higher CGT rate of 20%), but shares in VCTs are CGT exempt. Losses made on disposals of VCTs cannot be used to offset gains made elsewhere when calculating an investor’s total annual CGT. POINTS TO NOTE: An investor’s overall income tax liability cannot be negative (i.e. it is not possible to claim relief on tax that hasn’t been paid or isn’t due to be paid). If some of the shares are disposed of at a loss within five years there is a slightly more complex formula. The minimum holding period to retain the income tax relief is five years, starting from the date of the share issue. It ends on the fifth anniversary of the date of the share issue. If an investor disposes of their shares prior to the end of the five- year period, HMRC claws back the income tax relief. If all shares are disposed of at a loss within five years, the clawback will be equivalent to the sale proceeds multiplied by 30%.