26 / 92
26
Fledgling businesses need access to
finance, but since 2008 banks have
been reluctant to provide it, stifling
growth. VCT investors might take some
satisfaction that they are helping to
plug the funding gap and support a
vital part of the UK economy. This isn’t
solely altruistic though - the reluctance
of banks to lend means that there are
more opportunities and better value
deals available for the VCT managers,
and investors in those deals should be
well placed to benefit from economic
recovery.
Considering them as an asset class,
smaller companies can offer:
Higher investment growth than other
assets
Higher yields than other assets
More economic growth and job
creation than other assets
These benefits come with more risk
than other assets though, something
which we’ll examine later. The level of
risk does mean that in the vast majority
of cases, VCTs will only be suitable for
investors willing to accept a higher level
of risk for this portion of their investment
portfolio. That said a well-diversified VCT
may well have lower levels of volatility
than mainstream equities.
THE TAX BENEFITS
Assuming that the investment case for
a VCT makes sense, how much should
the tax reliefs influence any investment
decisions? Let’s remind ourselves of the
tax breaks for purchases of new VCT
share issues:
Income Tax relief of 30% on amounts
invested up to £200,000 per person, per
year
Tax-free dividends
Tax-free Capital Gains
Most planners would focus on using
up the majority of their pension and
ISA allowance before considering VCTs.
These two tax wrappers would account
for approximately £55,000 of investible
funds each year.
Lower pension limits mean that many
more people will find themselves looking
for alternatives sooner than they would
have previously. Some quick back-of-
the-envelope calculations tell us that (for
example) a 30 year old earning £45,000
a year, assuming a 3% annual pay rise,
12% net pension contribution and 7%
investment growth, would reach the £1
million lifetime limit before the age of 60.
This means at the height of their earning
power in their late 50s, a time of life
when they will be focused on investing
for their retirement, they have to look
for other tax-efficient options. In our
example above, the potential investor
would be paying around £46,000 Income
Tax a year - so an investment that gave
them the chance to get some of that
back, and provide a tax-free source of
income to supplement their pension in
the future would be attractive.
It’s a hypothetical example, but shows
how the pension lifetime limit is not
extraordinary anymore and many
people will reach it before they finish
accumulating assets. (Note that in our
example the hypothetical investor didn’t
get anywhere near the £40,000 annual
limit at any point.)
Finally, pension and ISA limits
notwithstanding, anybody who pays
a lot of Income Tax may very well be a
candidate for VCT investment in order to
make use of the relief. This isn’t just the
super wealthy. The average investment
into VCTs is £15,000, and the minimum
is £5,000, which does suggest that the
mass-affluent are using these products.
We’ll look at some other examples relating
to both accumulation and decumulation,
especially in the light of the new pension
limits and freedoms, later on.
Changes to the way that dividends are
taxed are also worth a mention here.
Under the rules announced in the July
2015 Budget, although the first £5,000
of dividend income a year will be tax-
free for everybody, sums above that
allowance will be taxed at 7.5% for basic
rate taxpayers, 32.5% for higher-rate
taxpayers and 38.1% for additional-rate
taxpayers. The new tax takes effect on
April 6, 2016. No tax will be deducted
at source; taxpayers must use self-
assessment to pay any tax due.
Dividend income is still included in the
personal allowance (£11,000 at the
time of writing) and another back-of-
the-envelope calculation tells us that a
portfolio with an annual yield of £5,000
would be worth in the region of £130,000
if it had a 3% yield. Investors who are
disadvantaged by this change might
consider the tax-free dividends VCTs
offer as a good alternative. There are
also planning ideas here for business
owners who pay themselves via
dividends - they could use a VCT to offset
the tax they pay.
SUMMING UP
There’s no need to overcomplicate the
investment case for VCTs. They offer
the prospect of both capital growth and
income. They support an important part
of the UK economy where traditional
sources of finance have withdrawn
from the market and therefore there
are a lot of investment opportunities at
valuations that favour investors. And on
top of it all they provide attractive tax
benefits, both at the point of investment,
ongoing and at encashment.
The investment case on its own is not
enough though of course: when it comes
to individual investors it will depend
upon their attitude to risk, capacity for
loss, tax position, levels of wealth and
“sophistication”, as well as their current
asset allocation.
The asset allocation point is an
interesting one, and there are two views
on this. One is that, for appropriate
clients, every portfolio should have
an allocation to higher risk alternative
investments, and that VCTs should form
part of this allocation. The other view is
that tax-advantaged investments should
be looked at on a case by case basis,
depending upon each individual client’s
tax circumstances and preferences.
Certainly, although the regulators will
view VCTs as higher risk investments,
there are lower risk options such as
Limited Life VCTs.
We’ll examine these concepts in more
detail in the following sections. And
of course there are risks around the
underlying investments, the way VCTs
are run and the rules that govern them.
BENEFITS
OF SMALLER
COMPANIES:
HIGHER YIELDS
THAN OTHER
ASSETS
%
MORE ECONOMIC
GROWTH AND JOB
CREATION
HIGHER
INVESTMENT GROWTH
THAN OTHER ASSETS