What Budget tax changes might we see? Five ways VCT tax relief could help

As always, ahead of the Budget the financial press is awash with predictions – this time, not if but which taxes will be raised. Whilst nothing is confirmed until 26 November, it is understood the Treasury is reviewing areas including:

• Dividend tax: the annual dividend allowance has already been reduced over the years from £5,000 to £500 – but what’s left could be scrapped altogether, to add around £325 million a year to tax coffers.
• Income tax: without raising headline income tax rates, the government could still adjust allowances or thresholds or extend the current threshold freeze beyond 2027/28 to increase the tax take indirectly.
• Pensions: higher-rate pension relief and the tax-free pension lump sum allowance are reportedly both under review. Currently, up to 25% of pension savings can generally be withdrawn tax-free, capped at £268,275. Cutting that to £100,000 could raise around £2 billion a year in the long run, it’s estimated.

Under the long shadow of a rising tax burden, investing tax-efficiently could become more of a priority. This article considers five ways VCT tax reliefs could come in handy – including for higher earners, those with restricted access to pension relief (e.g. buy-to-let landlords), and business owners seeking more tax-efficient ways to pay themselves.

Venture Capital Trusts combine upfront income tax relief, tax-free dividends and growth potential. There are a number of ways they could come in handy for experienced investors wishing to save tax whilst supporting innovative and fast-growing businesses.

Here are five common scenarios – you should form your own view.

1. If you wish to reduce your income tax bill

When you invest in a VCT’s newly issued shares, you can claim up to 30% income tax relief for the same tax year in which you invest.

For example: if you invest £10,000, the tax relief could be up to £3,000.

Using the full £200k allowance, you could save up to £60,000 on your income tax bill.

The amount of tax relief you can receive is limited by how much tax you owe on your income, whether it be earned, dividend or pension income.

2. An alternative way to invest tax-efficiently if you can’t add to a pension

If you’ve already used up your pension allowance or are unable to contribute, VCTs could be a tax-efficient alternative to consider.

For higher and top-rate taxpayers, the available rate of tax relief is lower than with a pension. However, the annual allowance is significantly more generous (£200,000 a year) and there’s no cap on how much you can invest over your lifetime.

3. If you wish to supplement your income – tax free

VCT managers typically aim to distribute any investment returns in the form of dividends, which can be useful for investors looking to supplement their income.

Importantly, unlike dividends from main stock market shares and funds, VCT dividends are tax free. If you’re an additional-rate taxpayer, it would take more than an 8% annual gross income from a unit trust or investment (taxed) to match the a 5% tax-free VCT dividend. Please note dividends are variable and not guaranteed.

4. If most of your income is from investments or property and you want to save tax-efficiently for retirement

Pensions are usually considered one the most tax-efficient ways to save for retirement, offering tax relief of up to 45%. Most people under age 75 can invest tax-efficiently up to £60,000 (or up to as much as they earn, if less) each year.

But what if you derive most or all of your income from investments, rental property, dividends, savings accounts and such (defined by HMRC as “unearned income”)? Then you might find the maximum you can contribute to a pension is a “non-earners” allowance of £3,600 (including 20% basic rate tax relief).

VCTs can provide an alternative, as you can invest tax efficiently up to £200,000 per year and receive income tax relief of up to 30%.

5. If you wish to make dividend earnings from your business more tax-efficient

Historically, many company directors and business owners tended to take most of their income in the form of dividends. This was normally considered more tax-efficient than taking a salary, as dividend tax rates have for years been significantly lower than income tax rates.

However, the gap is now closing – higher dividend tax rates and lower tax-free allowances are making dividends less tax-efficient.

Investing in VCTs could help, as the tax relief could be used to offset the tax due on the dividends. Moreover, you could potentially receive an income stream of tax-free dividends from the VCT.