For the use of professional advisers only and not to be
relied upon by retail clients.
Venture Capital Trust
October 2016
In an era of unpredictability,
VCTs look increasingly attractive
Leicester City…Brexit…President Trump? It looks like 2016 could
go down as the year when anything and everything became
possible. But as Stuart Lewis explains, the surge in demand for
Venture Capital Trusts (VCTs) feels entirely predictable.
This year has seen the introduction of two key changes to
legislation that will force financial advisers to think about
different ways to solve client challenges. The first relates to
the rules around pensions, while the second relates to the
way that dividends are taxed. Both of these could present
considerable opportunities for advisers to recommend VCTs
to their clients. Let’s consider both opportunities, starting
with the changes made to pensions.
Lifetime pension contribution limits
have almost halved since 2011
In April, we saw the lifetime allowance (LTA) for pension
contributions reduced from £1.25 million to just £1 million.
From April 2018, the LTA will move in line with inflation.
In addition, a tapered annual contribution limit has been
introduced, ranging from £40,000 (the upper limit) to as
little as £10,000 for those who earn £210,000 or more.
An LTA of £1 million may seem like a large amount, but as Table 1
shows, people of all ages (investing fairly small annual amounts)
who have already started to fund their retirement are likely to hit
the LTA a number of years before their actual retirement date.
I’m thinking specifically about younger investors with decades
of potential compound annual growth ahead of them and the
daunting prospect of an ever-increasing retirement age.1
You don’t have to cast your mind back too far to remember a
time when pension limits were much less punitive. As recently
as 2011, the LTA was £1.8 million, and the annual contribution
limit was £255,000. The penalty for breaching the new pension
limits is severe. If an individual’s pension pot ever exceeds the
limit, they could face a tax charge of up to 55% on the excess.
Perhaps unsurprisingly, in the latest tax year, the amount of tax
collected from those that breached the LTA jumped by 62%
to £126 million.2 It’s likely, therefore, that a growing number of
people may be forced to think more broadly than simply relying
on their pensions as the sole vehicle for retirement.
Table 1: The impact of the Lifetime Allowance
Clients
planning to
retire at 65
Pension pot
in 2016
Starting annual
contribution (gross)
Age they’ll first surpass the LTA
(assuming the LTA increases by
2% from 2018)
Value of pension fund at 65
Age 30
£125,000
£12,000
59
£2.7 million (£740k over the
estimated LTA at retirement)
Age 40
£350,000
£18,000
55
£2.7 million (£1.11 million over
the estimated LTA at retirement)
Age 50
£450,000
£24,000
61
£1.7 million (£402k over the
estimated LTA at retirement).
For illustrative purposes only. This assumes annual pension growth of 6%, annual pension contribution growth of 2% and the
LTA will increase at an estimated 2% CPI rate from 2018.
1
A 30 year old today is already looking at a state pension retirement age of 68 and there is every
possibility that this will be extended further.
2
HMRC, 2015/16 tax year vs. previous year.
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Dividend taxation could prove costly
for small business owners
Another significant change introduced this year that
could present many of your clients with food for thought
is the modernisation of the dividend taxation rules. The
introduction of an annual tax-free £5,000 dividend allowance
– instead of the previous regime of a notional 10% tax credit
on all dividends – should leave the average investor much
better off.
For example, at its current yield, an investor would need a
FTSE 100 portfolio worth well over £100,000 before they are
required to pay any tax at all on the dividends they receive.
However, things get more complicated for small business
owners and high-net-worth individuals. Above the £5,000
tax-free dividend allowance, the rates of dividend taxation
have increased to the following:
•
7.5% basic rate
•
32.5% higher rate
•
38.1% additional rate
This means that, despite the tax-free allowance, the army
of small business owners and personal service company
consultants who use dividend payments to supplement their
income risk being significantly worse off.
Given the way that dividends will now be taxed, we’re
expecting small business owners with surplus cash held within
their businesses to look for more tax-efficient ways to extract
profits. For some individuals, VCTs are proving a useful option.
Those clients who are already invested in VCTs can feel
reassured that the new rules only apply to new investments.
Existing investments will not be affected by the changes, and
there’s no requirement to sell any holdings that exceed the
new limits. What will change over time is the composition of
VCT portfolios in the future, as new investments made by a
VCT will typically be into younger, earlier-stage companies.
As always, there are certain exceptions and extensions
to ensure that the VCT industry continues to operate as
intended. One thought-provoking extension of the legislation
is the introduction of the concept of a ‘knowledge-intensive’
company. Such companies can benefit from more generous
VCT funding (£20 million rather than £12 million) if they
are considered to have a high proportion of highly skilled
employees or meet specific ‘innovation’ criteria. So those
VCT managers with considerable experience in ‘knowledgeintensive’ early-stage companies could have a significant
edge over other VCT managers.
Since the new legislation was announced, a number of
VCT providers have opted to either reduce the size of their
fundraising efforts or not to fundraise at all. If they believe
that their investment strategies will be significantly impacted
by the new legislation, then this makes perfect sense.
Of course, not all VCTs are created equal. While for some
VCTs this will alter the composition of the portfolio, it isn’t
necessarily a given for all. As always, it pays to do the
research and determine which VCTs are most likely to benefit
from the rule changes and which VCTs might not do so well.
What about VCT rule changes?
Venture Capital Trusts have experienced their own regulatory
changes in recent months, although it’s fair to say that
adjustments to VCT rules are much more ‘baked in’ to the
overall legislation. There have always been rules aimed at
ensuring VCT money is directed into the high-potential,
smaller companies that are most in need of finance. These
rules are recalibrated fairly regularly to ensure that funding
is directed to the most useful areas – and rightly so. But it’s
important to note that unlike the recent pension changes,
the new rules impacting VCTs do not affect the VCT wrapper
itself. The tax relief and structure for investors remains exactly
the same.
The Finance Act 2016, which received Royal Assent in
November 2015, introduced new rules in four specific
areas:
1.
A lifetime cap of £12 million on the amount of funding
that a company can receive from VCTs and Enterprise
Investment Scheme (EIS) sources
2. An age limit of seven years during which the first VCT or
EIS investment must be made
3. A restriction on VCT money being used simply to transfer
ownership of a company or trade – VCT money must
explicitly be used to fund growth and development
4. Tighter restrictions on what VCTs can do with their
money while waiting to make qualifying investments
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Tails.com, a dog food
delivery company with
VCT funding.
Summary
Four ways to get ahead of the
VCT tax year-end rush
Venture capital trusts look set to benefit from their new
role as a more mainstream part of a retirement planning
portfolio. This is particularly true for investors that have
reached, or are coming close to, the limits of a traditional
pension investment, or are considering another tax-efficient
investment approach. The upsurge in demand for VCTs is
confirmed by the fund inflows. According to the Association
of Investment Companies (AIC), VCTs raised £458 million for
the 2015/16 tax year, making it the biggest fundraising year
in a decade.
1. Swot up on VCTs by attending VCT training
events, seminars or webinars. The AIC offers a
range of tools to learn more about VCTs and
investment trusts. Alternatively, at Octopus, you
can visit the adviser section of our website for
VCT-related material, including a range of client
planning scenarios.
2. Talk to your clients early – given that VCT
fundraising could be limited this year, and that
many providers offer early-bird discounts for early
applications, it is worth talking to your clients
about the benefits (and risks) of VCTs right away,
thereby getting ahead of the curve.
From a supply/demand perspective, the reduced number
of VCTs open for investment coupled with the increased
demand for VCTs means that both advisers and investors
should be warned that their favourite VCTs could fill up fast.
In years gone by, tax-efficient investment was something to
think about mostly in the few months before tax year end.
This is no longer true. There’s a strong case to invest in VCTs
at any time of the year, while stocks last. If the experience
of 2016 is to teach us anything, it is that if you spot an
opportunity early, take it – just like Leicester City did.
3. Take advantage of discounts – as well as the
early bird discounts mentioned above, VCT
managers often offer loyalty discounts for
existing clients. When combined these can be
quite attractive.
Stuart Lewis
Business Line Manager for VCTs at Octopus Investments
4. Don’t leave it to the last minute – be aware
that supply may well be low from January to
April. Act now to get the pick of the best VCTs
this season.
Investors put £458 million into VCTs in
2015/16 tax year, the largest amount for
a decade.1
Eve is an innovative
mattress company
with VCT funding.
1
Association of Investment Companies, May 2016
Get in touch
To discuss any of the content of this Octopus Insight further, or to learn more
about our range of VCTs, please contact our Business Development Managers on
0800 316 2067 or email [email protected].
For professional advisers only. Not to be relied upon by retail investors. The value of an investment, and any income from it, can fall or rise.
Investors may not get back the full amount they invest. Tax treatment depends on individual circumstances and may change in the future. Tax
reliefs depend on the portfolio companies maintaining their qualifying status. The shares of the smaller companies we invest in could fall or rise in
value more than shares listed on the main market of the London Stock Exchange. They may also be harder to sell. Personal opinions may change
and should not be seen as advice or a recommendation. We do not offer investment or tax advice. We recommend investors seek professional
advice before deciding to invest. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority.
Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. We may record telephone calls to help improve
our customer service. Issued: September 2016. CAM04029-1607
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