Pixel

Venture Capital Schemes: Tax Relief Guide For Investors

Gary Green
Gary Green
July 5, 2021

When it comes to finding out what tax relief is available for investors using a venture capital scheme, it's important to understand what the scheme is first.

Essentially, a venture capital trust, or VCT, encourages investment in unquoted, small trading firms. The aim is to support entrepreneurial small companies because they need investment capital to help them develop and grow.

As a result, the UK has created the world's most successful market for this purpose.

An investor in a VCT will enjoy:

  • Up to 30% upfront income tax relief
  • Tax-free dividends
  • Their investment is capital gains tax (CGT) exempt on the rise in the share's value.

The bottom line is that venture capital trusts support entrepreneurial companies, but they may not be successful or may take several years to achieve success.

It is the tax incentives that help compensate an investor for taking a higher risk with their money.

Venture Capital Trust Schemes

A venture capital trust scheme will see an investment being spread over several companies to help reduce risk.

This will see investors subscribing for shares in a VCT which will be a company that has a London Stock Exchange listing.

A VCT will be run by fund managers, and they are generally members of a bigger investment group.

There are some rules for unquoted small trading companies to qualify and they are recognised as:

  • Having up to 249 employees
  • Total gross assets of up to £15 million before investment
  • Total gross assets of up to £16 million after investment
  • The amount raised annually by a company is restricted to £5 million.

Most of these changes were introduced in April 2012 which is when the £1 million cap was removed for investment by a venture capital trust in a single company.

Rules for VCT Investment

However, the rules were changed slightly for VCT investment in the 2015 budget to include:

  • For a knowledge-intensive company, the total amount of investment is capped at £20 million
  • For a knowledge-intensive company, the limit on employees was raised to 500.

The budget also saw a new cap being applied on the total investment a company can raise under a VCT for a knowledge-intensive company of £15 million.

This was also the budget that determined that the generation of renewable energy and the provision of reserve energy generating capacity were no longer qualify activities.

The Principal-Based Test

And because VCTs were so popular, new qualifying conditions were brought in by the UK Government in the 2017 budget, including the principal-based test.

This is to determine whether the company seeking finance is a genuine entrepreneurial firm, or not.

It was this measure that also led to the rules excluding investments that are ‘tax-motivated’ - this is where the tax relief provided most of an investor's return but limiting the risk to their original investment.

The new rules take a 'reasonable' view on whether an investment has been deliberately structured to offer a low risk.

This rule sees two parts being introduced with a company having long-term objectives to develop and grow, and whether the investor faces 'significant risk' of losing their capital.

What VCT Income Tax Reliefs Are Available?

Tax relief for investors in a VCT is a 30% income tax credit of the new ordinary shares cost, up to a 'permitted maximum' of £200,000.

This can be set against an investor's income tax liability in the year of investment when the shares were issued.

This annual limit will apply to the taxpayer's VCT acquisitions for the tax year concerned so their maximum income tax liability reduction in any given year will be £60,000 - but only if there is sufficient income tax liability.

We can explain how the system works with this example:

  • The investor subscribes £20,000 for shares
  • The maximum income tax relief for the investor will be £6,000
  • If their actual liability in the year before there is any VCT tax relief was £5,000, then that's the relief they would receive.
  • The £1,000 difference cannot be set off against their income tax liability in any other year.

It's also worth noting that to qualify for VCT income tax relief, the subscribed shares must be held for five years at least.

However, the VCT share dividends are exempt from income tax if they have been bought within the permitted maximum of £200,000.

It is here that VCTs offer the prospect of a tax-free dividend - for example, a dividend of 5% equates to a taxable dividend of 7.41% for a higher rate taxpayer, and 8.1% for additional rate taxpayers.

For those considering VCT investments, a well-established and diverse portfolio could deliver dividends throughout the year.

How To Claim VCT Tax Relief

Normally, an investor can claim their VCT tax relief when they file their tax return.

They would either reduce their tax bill for the year, or they will receive a refund for the tax they have already paid.

VCTs and Inheritance Tax

For those who are looking at the prospects of a VCT, you may be wondering whether a VCT is subject to Inheritance Tax (IHT).

Essentially, a VCT will not qualify for inheritance tax relief, but the VCT's underlying holdings may do. To explain this, when an investor buys their shares in a VCT, you do so in the VCT plc, and not in its underlying holdings.

It's only when an investor holds shares directly in a particular company that they will be IHT free.

Front-end income tax relief for VCT withdrawal

Having mentioned that the subscribed shares need to be retained for five years, what happens if the shares are disposed of within five years of them being issued?

The front-end income tax relief, in part or in whole, will be withdrawn under the circumstances.

Also, disposal between civil partners or spouses who live together will not give rise to a withdrawal.

And should a VCT lose its approval, the front-end relief may also be withdrawn.

The rules also make clear that death does not give rise to the withdrawal of front-end income tax relief.

Why invest in a VCT?

A VCT offers great investment potential for many investors and there are tax benefits to be enjoyed.

However, a VCT may not be suitable for all investors and it's important to speak with a financial adviser before investing in a VCT to see whether this type of investment is the right one for you.

Indeed, the Financial Conduct Authority (FCA) treats VCTs as designated investments.

So, anyone advising on VCTs - just like advising on most other investment types -is doing so on a regulated activity and the financial adviser must have the relevant permissions from the FCA to do so.

If you have any questions about the issues raised in this article, we at Key Business Consultants can help. Get in touch with us today or call us directly on 020 3728 2848.

Interested in our services?
Fill in your details and a member of our experienced team will be in touch shortly to discuss your needs.
We adhere to strict GDPR rules and do not reveal or sell your data to any third-parties. For more, please read our Privacy Policy.
Latest Insights
March 4, 2022
An Overview of EIS (Enterprise Investment Scheme) - All You Need to Know

There are several benefits for the EIS, or Enterprise Investment Scheme, to make this an interesting...

March 3, 2022
Tax Relief for Angel Investors: Gary Green's Webinar for Stakeholderz

Key Business Consultants' principal Gary Green spoke with Stakeholderz discussing the SEIS & EIS scheme and...

February 23, 2022
What Are EMI Share Schemes? All You Need to Know

If you are considering awarding shares to your employees, an Enterprise Management Incentive is often the...

January 31, 2022
Payments on Leaving Employment: How to Reduce Your Tax Liability

Normally the process for leaving employment is quick and straightforward but this is not always the...

January 17, 2022
HMRC Investigations: What You Need to Know

Discovering that you are being investigated by HMRC can be very stressful, even if you are...

January 14, 2022
Business Transactions - Guide to Planning and Executing Efficiently

There are some transactions in business that are significant and require substantial forward-planning to be a...

January 12, 2022
Why Employee Equity is an Important Issue For Every Business

Being a business leader is about being willing to embrace innovation and be flexible about how...

January 10, 2022
An Employer’s Guide to Settlement Agreements

If you need to terminate the contract of an employee, a properly drafted settlement agreement can...

January 7, 2022
Taxation of Private Company Shares - What Should You Know?

Many companies opt to reward their employees with shares or options because of the manifold benefits...

View Our latest insights »
Get the latest UK tax & business news and guidance delivered straight to your inbox
We care about the protection of your data. No spam. Unsubscribe anytime.
Copyright © 2022 Key Business Consultants LLP. Reg: E&W OC389322
linkedin facebook pinterest youtube rss twitter instagram facebook-blank rss-blank linkedin-blank pinterest youtube twitter instagram