There is growing anticipation that planned tax changes will significantly affect high earners. While Chancellor Rachel Reeves has indicated that income tax hikes are off the table, other taxes, such as CGT, as well as dividend tax allowances and pension tax reliefs, are squarely in the spotlight. For investors, tax-efficient vehicles like VCTs could offer a crucial advantage in a tightening tax environment.
The Labour government is under pressure to fill a significant revenue shortfall, described as a £22 billion 'black hole’. It is widely expected that higher-rate taxpayers will bear most of the burden, particularly through changes to CGT and further cuts to the tax-free dividend allowance (already halved to £500 from 2024), so investors are exploring new strategies to protect their wealth.
It's a common misconception that CGT only affects the wealthy as more taxpayers are being pushed into higher tax brackets due to the impact of fiscal drag, where asset values rise but tax allowances remain static. With inflation and earnings rising in recent years, this effect is becoming more pronounced.
In this uncertain landscape, VCTs present a particularly appealing option, offering generous tax reliefs, including 30% upfront income tax relief on investments up to £200,000 per year, tax-free dividends, and exemption from CGT. As tax liabilities increase elsewhere, VCTs stand out as a smart solution for investors seeking to manage their tax burden*.
One of the most compelling benefits of VCTs is the 30% initial tax relief, which for example would provide £30,000 income tax relief on an investment of £100,000 in new VCT shares. For higher earners, who are most likely to face rising tax liabilities and limits on other tax-efficient savings options, investing in VCTs can significantly reduce their income tax liability.
With erosion of the dividend tax allowance, the ability of VCTs to pay tax-free dividends adds even more appeal, particularly for high earners relying on dividend income, this offers a valuable source of tax-free returns. Many VCTs aim to pay annual dividends of 5% or more, which are entirely tax-free and can help offset the reduction in their dividend allowance.
Moreover, unlike many other investments, gains from the disposal of VCT shares are exempt from CGT, which is particularly appealing for those with substantial investment portfolios in the face of CGT hikes.
VCTs offer a unique opportunity to support innovative UK businesses in growth sectors while enjoying the benefits of tax incentives. More than £2 bn was invested in VCTs across the 2021/22 and 2022/23 tax years, and 2023/24 tax year seeing the third highest VCT fundraising year (Source: Wealth Club). This increased appetite is driven by investors recognising VCTs as an established, complementary asset class offering a strong track record from long established funds and highly experienced specialist managers.
Despite a volatile macroeconomic environment, a number of VCTs have performed well, particularly for those able to hold the investments long term and with less pressure to generate immediate liquidity. Although VCTs primarily invest in earlier stage, higher risk companies, the ability of larger VCTs to diversify across sectors helps mitigate some of the associated risks.
If, as anticipated, Rachel Reeves announces increases to CGT and changes to dividend and pensions allowances, VCTs could play an even more significant role in investors’ portfolios. The sector has the expertise and track record to offer an attractive, established tax efficient alternative and a way for investors to tap into the growth potential of the UK’s venture capital ecosystem. No longer simply a niche option solely for the wealthy, investors are increasingly recognising the value of VCTs as an important tool for those navigating the evolving tax landscape while supporting some of the most innovative companies across the UK.
*An investor should never make investment decision solely because of tax benefits. Tax rules can change, and benefits depend on circumstances.