JEFF PRESTRIDGE: How to cut your income tax bill by 20 PER CENT

One of Rachel Reeves’ parting shots as Chancellor was to chip away at the tax breaks available to those investing in venture capital trusts (VCTs).

Yet despite the move – much derided given the Government’s wish to get people investing more, not less, in British businesses – investment commentators insist these trusts can still play an important role in long-term financial planning.

For income-seekers, in particular, they can provide a rich seam of tax-free dividends to complement income from other sources such as pensions and Isas. They can also mitigate tax bills.

But investing in these trusts is high risk, and investors need to be aware that capital returns can be compromised if any of the underlying unquoted companies held within VCTs fail.

Alex Davies, founder of investment service Wealth Club, says: ‘VCTs give you the chance to become an angel investor and support the country’s most promising start-up businesses – the likes of digital health company Oviva, London-based AI and data analytics software firm Quantexa and fintech company OpenTrade. But they are high risk.

‘Look beyond the attractive tax breaks because they are just the icing on the cake.

‘The underlying investments need to make sense and you should spread your money across different VCT managers.’

Here, Wealth & Personal Finance spells out the opportunities that VCTs offer – and how you can get a slice of the action.

What is a VCT?

VCTs provide much-needed finance to fledgling companies. The trusts are listed on the London Stock Exchange but the businesses they inject capital into are not – they are unlisted, private and often embryonic.

For the most part, they have assets of no more than £30million.

To put this into perspective, BP’s assets are north of £200 billion. Major investment houses that run VCTs include Albion Capital, Foresight Group, Maven Capital Partners and Octopus Investments.

Juicy tax breaks

Investors are encouraged to invest in VCTs through three key tax breaks.

The first is 20 per cent income tax relief on an investment of up to £200,000 in the current tax year (cut by Ms Reeves from 30 per cent in the previous tax year).

So on a £50,000 investment you get tax relief of £10,000, which can be set against your income tax liability for this tax year.

At best, it can wipe out your income tax bill.

But there are strings attached. The money must be invested in new shares issued by a VCT as part of a fundraising round, not in shares bought via the stock market. The fundraising season has just begun and will run up to the end of the tax year in April.

Also, you must then hold the shares for at least five years. If you need to sell them earlier – for example, to meet a financial emergency – the taxman will claw back the tax relief you enjoyed at the start of your investment.

Second, any capital gains you make from your investment will escape nasty capital gains tax (CGT) which Chancellor John Healey is likely to ratchet up in next month’s Budget. 

Any excitement over this CGT exemption should be tempered by the fact that capital profits from VCTs can be meagre, with most of the gain coming in the form of dividends.

The latest performance figures from the Association of Investment Companies shows that, over the past five years, the average VCT has recorded a share price total return (combined capital and income returns) of 14 per cent. Over ten years, the average return is more respectable at 37 per cent.

Trusts with the best ten-year records are run by Albion, Gresham and Foresight.

Third, and most interesting for readers, it’s the income opportunity from VCTs that many will find compelling. It’s tax-free and can mount up. Exclusive research by Chelsea Financial Services for Wealth & Personal Finance shows that 13 out of 29 VCTs have paid out total tax-free income equivalent to at least 70 per cent of their 2016 asset value over the past ten years.

VCT Albion Enterprise has delivered dividends totalling 71.95p over the past decade. This represents nearly 75 per cent of its 2016 asset value (96p a share).

This dividend stream has driven a total return of 133 per cent, assuming the divis were automatically reinvested.

Peter Hicks, research analyst at Chelsea, says: ‘If you look back over the past ten years we’ve had seven prime ministers and seven chancellors – with the country having to respond to Brexit, the pandemic, AI and trade wars.

‘Despite all of this, the VCT sector has held true, maintaining an impressive consistency in delivering tax-free income to investors.’

Who should buy them?

Sarah Coles, head of personal finance at investing platform AJ Bell, says the high level of risk associated with VCTs means they are only suited to experienced investors with large existing investments held across pensions and Isas.

She adds: ‘As a rough idea of where they fit in the broader investment picture, just short of 22,500 investors claimed income tax relief on them in the tax year ending April 5, 2025.

‘This compares to 15 million adults who paid into Isas in the tax year before that.’

Jason Hollands, managing director of Bestinvest, part of wealth manager Evelyn Partners, agrees.

‘VCTs should be considered by a relatively small group of investors – namely, high earners who face significant income tax liabilities and have already fully used their annual Isa and pension allowances,’ he says.

Davies says: ‘If you can’t afford to lose money you are investing, or are uncomfortable at having money locked up for a long time, you shouldn’t touch them. They are also not a substitute for a pension, emergency savings fund or a low-risk income portfolio.’

How to buy them

A number of established VCT managers are raising, or about to raise, money for their funds. They include Albion, British Smaller Companies and Pembroke.

In opting to buy VCT shares at a fund raising, rather than via the stock market, you will get 20 per cent tax relief on the investment you make.

Details of current VCT offers are available from major investing platforms and specialists such as Chelsea and Wealth Club.

Davies says: ‘VCTs give you different flavours of exposure to small companies with growth potential. So spread money across different managers, and ensure the VCTs are invested in a decent number of companies.

‘That gives you a lot of shots on goal.’