In this tax-planning scenario, we explain how a Venture Capital Trust (VCT) could be used to reduce income tax.
Mr Banks is a director of a company. Mr Banks earns a large salary. He has significant savings and pays into his pension each year. With a high annual tax bill, Mr Banks is interested in ways to reduce income tax that he pays. He would consider investing in UK smaller companies and is comfortable with the associated investment risk.
The tax-planning solution
We looked at his risk profile, investment time horizon (of more than five years) and attitude towards smaller company investing. Given this, we suggested investing in a Venture Capital Trust (VCT).
With a VCT, Mr Banks can claim up to 30% income tax relief on up to £200,000 invested in any single tax year, provided he holds his VCT shares for at least five years. Mr Banks can also benefit from tax-free dividends, and no capital gains tax to pay when he sells the shares.
We explained how Mr Banks could use a series of VCT investments to continue claiming income tax relief in future years. For example, if Mr Banks invests £50,000 in year one, he can claim £15,000 tax relief for that year. In year two, he can invest another £50,000 and get an additional £15,000 income tax relief, and so on in years three, four and five.
In year six, after his first VCT investment reaches the five-year mark, Mr Banks can choose to sell these shares. He could then use the proceeds to invest into another VCT, using his first year’s capital to claim fresh income tax relief in year six. In the following year (year seven) he can then sell and reinvest his year two investment and again claim further income tax relief. And so on.
Invest £50,000 and get £15,000 income tax relief
Mr Banks can claim income tax relief from each VCT investment he makes across several consecutive tax years. We used six years, but in practice he could use this method to keep reducing income tax indefinitely.
After six years, Mr Banks could claim £90,000 in income tax relief from a £250,000 investment.
This is, of course, subject to certain conditions including the requirement to hold VCT shares for at least five years in order to retain the 30% upfront tax relief. VCTs are high risk and are not suitable for everyone. If an investor needs guaranteed income, cannot tolerate loss or is uncomfortable losing immediate access to their money, then VCTs are not suitable. It is also worth noting that after selling shares in a VCT, it is not possible to claim tax relief on new shares bought in the same VCT within six months of the initial sale.