Mechanics of the VCT tax break

SpeedSouth

Hi,

Read a few posts on VCT tax breaks and things and just wondering if I am understanding them correctly. Irrespective of risks and whether they are for me etc etc.. just keen to understand.

My understanding is a purchase of a VCT reduces your tax liability by 30% of the amount purchased, so an example would be.

Person earns £45,000, and has a tax free allowance of 11,500 so pays £6,700 in tax.
If they were to purchase £10,000 of VCT funds, does this essentially raise your tax free allowance to £14,500 (by 30% of £10,000), meaning you are now paying £6,100 in tax.

If my understanding is correct, is it then a cumulative system whereby an investment of £110,000 in VCT would at 30% almost completely offset your tax liability.

Of course your income would likely go, but if you remained earning £45k is the thinking correct?
Thanks

masonic

Your understanding is correct*, but it would probably be unwise to put such a large amount into VCTs each year. Most people would use pension contributions to reduce their taxable income to a lower level, then might opt to use VCT contributions to offset some of the residual income tax.

* see below

Dazed_and_confused

No, it does not have any impact whatsoever on your personal tax allowance.

The VCT tax relief is a credit which reduces your overall tax liability, see link below which explains this

For some this would possibly not be much different overall but it will be for others and your post was about the mechanics of VCT, which are most definitely not how you describe them.

In your example wouldn't a £10000 investment reduce the tax due from £6700 to £3700???
(I have assumed your £6700 figure is correct for whichever country you live in Scotland or rest of UK).

If you complete self assessment tax returns online you could put these figures into your 2016:17 return as a test to see how the overall liability is calculated.

https://www.moneyadviceservice.org.uk/en/articles/venture-capital-trusts

chucknorris

You have to be careful not to be tempted into investing solely by the lure of the tax relief, I started to look at these, but I decided that in my case I was in danger of letting the tail wag the dog.

masonic

Dazed_and_confused wrote: »

No, it does not have any impact whatsoever on your personal tax allowance.

The VCT tax relief is a credit which reduces your overall tax liability, see link below which explains this

For some this would possibly not be much different overall but it will be for others and your post was about the mechanics of VCT, which are most definitely not how you describe them.

You're right, I completely overlooked this. The difference between paying £3,000 less tax and getting £3,000 more tax free allowance is significant even for the OP. Without VCT, he'd be paying £6,700 in income tax, whereas with a £10,000 contribution he'd be paying just £3,700 and would only need to double his contribution to almost wipe out his income tax liability.

Still, paying almost half your income into VCTs is going to quickly unbalance your investments, even if you start to recycle money after 5 years.

bowlhead99

Hopefully this is covered / explained by the posts above. Basically:

adam81 wrote: »

Hi,

My understanding is a purchase of a VCT reduces your tax liability by 30% of the amount purchased

Yes, as long as :

1) it's a new issue of shares​ by the VCT and not just you buying some existing VCT shares from someone else via the stockmarket ;

2) your tax liability was at least as much as the [30% of the amount purchased] in the first place. So for example if your income tax bill for the year after all your other reliefs (pension, charity etc) is only £6700, you can't invest £22666 and get £6800 of relief leaving HMRC owing you £100. In that case the relief would be restricted to £6700 only and not the full £6800; you'd be better to invest the last £333 the next year and just invest £22333 for the £6700 of relief you can actually use in the current tax year.

If my understanding is correct, is it then a cumulative system whereby an investment of £110,000 in VCT would at 30% almost completely offset your tax liability.

Hopefully you can see from the above that £110k will produce a saving of £33k of tax which is way more than you need to save in any one year, so at your theoretical level is earnings of £45k tax and £6700 normal tax bill, you shouldn't try to invest that much in any one year. The limit is £200k in any one year if you happen to find yourself with a multi million pound windfall from somewhere.

But yes it is "cumulative" in the sense that if you invested £10k a year for eleven years to make £110k cumulative investment cost, you would have cumulatively saved £33k (being £3k off your income tax bill each year).

Of course, the setup and operating costs of the VCTs together with investment losses which they might deliver, could amount to £33k or more. But as you say, there are other threads which discuss risks, pitfalls etc. VCT has become relatively less attractive as an investment class in recent years due to the tightening of restrictions on what qualifying investments the VCT manager is actually allowed to make with your money within the rules of the regime.

Morphoton

2) your tax liability was at least as much as the [30% of the amount
purchased] in the first place. So for example if your income tax bill for the
year after all your other reliefs (pension, charity etc)

Is this correct ?
As I understand it you can eliminate your income tax liability using VCTs but still pay into a pension 100% income or 40k and get basic tax relief up to the full amount paid in.

Reaper

Morphoton wrote: »

Is this correct ?
As I understand it you can eliminate your income tax liability using VCTs but still pay into a pension 100% income or 40k and get basic tax relief up to the full amount paid in.

My understanding is if you are a non-taxpayer (for any reason) then the most you can put into a pension and get tax relief on it is £2880 pa, the taxman then chucks in £720 to give you a total of £3600. Whether the VCT or pension calculation comes first in sequence I couldn't say.

jamesd

The VCT buying reduces the calculated tax bill. There won't be any tax bill remaining if you have paid enough into a pension to eliminate it all, so no remaining tax bill means no VCT relief.

Do all of the other calculations for pensions, starter rate for savings, savings allowance, personal allowance, dividend allowance, capital gains tax and whatever else. If that results in tax being due, VCT or EIS purchases can reduce it.

For the pension contributions it's irrelevant whether you are a tax payer or not, you can still pay in and get basic rate relief, so long as it's not a work salary sacrifice or work net pay scheme. The 2880/3600 comes into play if you don't have that much earned income and you get to do that and get basic rate tax relief added by the usual relief at source pensions even within your tax free personal allowance. It's a top up to your income calculation, if income is less than 3600, pretend it's 3600.

SpeedSouth

Thanks all,
So the relief only comes in the year you purchase the VCT? You won't get £3k relief on a £10k purchase for the following 5 years?

As I said I was simply interested to learn the mechanics having read a lot about them on here. They are not at present part of my plan.

bowlhead99

adam81 wrote: »

Thanks all,
So the relief only comes in the year you purchase the VCT? You won't get £3k relief on a £10k purchase for the following 5 years?

Correct on both counts.

If you make a £10k purchase you get a £10k investment but you will receive a £3k rebate of your income taxes that you'd paid for the year (or reduction in the tax bill you were going to get for that financial year). So the investment has only cost you £7k net. It is a financial incentive from the government to encourage you to invest into a portfolio of risky early-stage companies which might otherwise find it difficult to raise money.

When you get dividends from the VCT fund in future, you won't pay a penny of tax on them regardless of your tax bracket or the total amount of dividends you receive in the year from other sources. If you sell the shares for more than you paid for them, you won't pay a penny in capital gains taxes regardless of how much gains you make in a year. So it is a good scheme. The only stipulation is that if you dispose of the shares within 5 years of buying them, you have to pay back that initial £3k relief (or half of it if you sold half of them, etc).

But no, you don't get another £3k tax rebate for the next 5 years on the same initial investment - otherwise by year four the investment will have cost you less than zero