This year is predicted to be a record year for bonuses, but the lucky recipients will have to consider maximising their tax breaks.
Wealthy investors have borne the brunt of new tax restrictions on saving and many cannot put any more cash into their pensions. The lifetime allowance, the total amount you can hold in a pension without incurring a tax charge of up to 55 per cent, was £1.8 million in 2012 but was cut three times to hit £1 million in 2017. Three small increases since have brought it up to £1,073,100, where it will stay until 2026.
If you are a high earner, the annual allowance of how much you can pay into a pension, tax-free, could be as low as £4,000. Most savers can pay in £40,000 a year but this threshold is tapered so some people earning more than £200,000 lose £1 of allowance for every £2 of salary they earn over the “adjusted income” threshold of £240,000.
Other investments, such as buy-to-let properties, have become less attractive to high earners thanks to other tax changes that affect the relief you can claim on mortgage payments.
And taxes on dividends have increased significantly and are set to rise even further next month, eating up the returns of any investments held outside a pension or Isa.
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There are other options, though: as long as you can tolerate a high level of investment risk, there are attractive tax incentives for using Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EIS).
Here’s what you need to know.
VCTs
VCTs are a type of investment company that invests in small UK businesses. To encourage support for firms in need of next-stage funding, VCTs offer several generous tax benefits.
For every pound you invest in a VCT you can get up to 30p back in tax relief. They offer tax-free capital gains and tax-free dividends. You can invest up to £200,000 into a VCT each year and get up to £60,000 back in tax — although you cannot claim back more tax than you owe.
To qualify for the tax break you must hold the investment for at least five years. A VCT itself is a fund that invests in a basket of typically 50-80 privately owned fast-growing companies. You buy shares in a VCT and the fund manager will choose the businesses to invest in. These range from tech firms to consumer brands. Some contain only firms that are listed on the Alternative Investment Market (Aim).
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Most VCTs target an annual 5 per cent dividend, but some can pay significantly more.
Wealthier investors are increasingly looking to VCTs. In this tax year £906 million has been invested in VCTs, more than double the amount at the same point of the last tax year.
Alex Davies, the founder of the Wealth Club, an online broker, said: “The main contributor to the surge in VCT popularity has been pension restrictions on wealthier investors who are seeking attractive tax breaks. Demand for VCTs has been phenomenal this year and popular offers are selling out very fast.”
Amati’s Aim VCT sold out within five days of launch, raising £25 million from private investors. Some £13 million was pledged in the first 90 minutes and £21 million was raised on the first day.
VCTs can give you higher returns — especially once tax relief is factored in. In the five years to December 2021, the average VCT returned 38 per cent.
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Many VCT-backed companies have become or are on their way to becoming household names.
So far there are eight that have earned “unicorn” status — private companies with a valuation of $1 billion or more. These include the online car retailer Cazoo and the meal kit business Gousto, backed by Joe Wicks, the fitness coach who helped us all get through lockdown.
There are risks of course. VCTs invest in early-stage businesses, which are much more likely to fail, and the companies they invest in can be harder to sell.
Most VCTs offer a buy-back facility where they aim to buy your shares from you at a discount to NAV (net asset value) of 5 per cent, although this is not guaranteed.
While dividend targets are attractive, they are not guaranteed either.
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Ben Yearsley from Shore Financial Planning said: “VCTs are often the first port of call for wealthier investors looking for tax breaks and a long-term income producing asset. But it’s important to understand the risks as well as the high charges on these vehicles.
“The well-run VCTs have got bigger but the charges haven’t come down by as much as they should have to reflect scale. You’re likely to pay annual charges of 3 per cent and most have opaque performance fees.
“Make sure you understand what you’re buying, and that you are not just investing for the tax break.”
EISs
There are some useful tax advantages in an Enterprise Investment Scheme too. There is income tax relief at 30 per cent and returns are free of capital gains tax if held for three years.
They also allow you to defer capital gains tax (CGT). For example, if you have a chargeable gain, such as from selling an investment property, and invest in EIS, you can defer that gain to the following tax year and any CGT due on it for as long as you remain invested in the EIS.
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When the EIS is sold you crystallise the original level of gain, regardless of what you sell the EIS for.
You can also get loss relief (at your marginal tax rate) and there would be no inheritance tax due so long as you have had the EIS investment for two years when you die. The maximum you can invest is £1 million in a tax year, or £2 million if anything over £1 million is for “knowledge intensive” investments — in other words those carrying out research, development or innovation in a particular sector.
EIS investments offer a “carry back” facility where you can elect for all or part of your EIS shares bought in one tax year to be treated as though they were bought in the previous tax year.
You can invest in a single company or a fund that holds a cluster of firms in one pooled investment.
Risk-wise, it is harder to gauge how EISs perform because there is no performance data from independent sources. An EIS fund might only hold 10-12 companies, which is a narrower and thus potentially riskier, pool than a VCT.
There are high risks of investing in small companies, but the opportunity to apply for loss relief if an EIS fails can cushion any losses.
Yearsley said: “The managed EISs mean you don’t have to pick the companies yourself, but they can be extremely pricey, costing up to 6 per cent a year.
I prefer the single company EISs. With loss relief you have extra protection against losing money. If you have one good winner out of ten, you’ve probably still made money.”
Investments in EIS and VCT schemes are not protected by the Financial Services Compensation Scheme, the industry safety net.
Popular picks
Davies likes Albion VCT. “The focus is on business-to-business software companies at the larger end of the spectrum,” he said. “Although it will consider a smaller number of earlier stage companies too. The portfolio also contains some mature asset-backed investments such as renewable infrastructure assets and schools. These mature income generating assets help to underpin the dividend, and it’s this dividend that is its key differentiator.”
Davies also likes the Triple Point 2011 VCT, which contains a portfolio of 30 companies and has a bias towards financial technology businesses.
He said: “Few large VCTs remain open this late into the tax year, however for those investors that are keen to back an up-and-coming VCT or wish to further diversify an existing VCT portfolio, the Venture share class of the Triple Point 2011 VCT is worth a look.
“Holdings include Vyne Technologies, the account-to-account open banking payments platform, and Ably Real-Time, the data infrastructure platform, which recently raised $70 million, at a sizable uplift in valuation, to almost triple the size of its team and expand into the US.”
Yearsley likes Pembroke VCT, which has a relatively concentrated portfolio with over half its money invested in ten companies.
He also likes Maven VCT, which invests in unquoted companies.
“It’s a good idea to see what brokers are offering to help with your research,” he added.
Yearsley suggested the Downing EIS, which mainly invests in health and tech companies such as Open Bionics, a designer, manufacturer and supplier of bionic limbs, and Hummingbird, a crop analytics business.
Davies suggested the Octopus Ventures Knowledge Intensive EIS fund.
“Octopus Ventures has built a reputation for investing in some of the UK’s fastest-growing private technology companies,” he said. “Its VCT track record includes backing four companies that have achieved unicorn status and several have achieved high-profile exits with trade sales to the likes of Microsoft, Twitter and Amazon.
“Unlike a normal EIS fund its knowledge-intensive structure allows investors to claim tax relief in the year the fund closes.”
The fund will close on April 1, 2022, meaning investors can claim tax relief in the current or previous tax year. Investors in the fund will get a portfolio of 10-15 companies.
The $1 billion start ups backed by VCTs
• Zoopla Property portal
• Cazoo Online car retailer
• Gousto Meal kit retailer
• Bought by many Pet insurer
• Depop Peer-to-peer social e-commerce company
• Matillion Software company
• Thought Machine Core banking platform
• Interactive Investor Investment platform for private investors
‘Investing in new businesses is actually rather addictive’
John Threlfall, 68, has saved up to the tax limit of his personal pension and maxes out his Isas each year (Holly Thomas writes).
With the rest of his investable cash, John, a university lecturer in London, uses Venture Capital Trusts (VCTs) and the Enterprise Investment Schemes (EIS). “The tax incentives are excellent,” he said. “And for those like me who enjoy the world of finance and reading about new and exciting business ideas, it’s actually rather addictive.”
His most profitable investment has been with Octopus, a VCT that contains the online motor retailer Cazoo, which floated on the New York Stock Exchange in August with a £5 billion valuation. Its shares have since halved in value. “The special dividend from Cazoo turbocharged returns.”
Threlfall gets about £20,000 a year in dividends from his VCT investments, tax-free.“It’s great as an income or to reinvest. And best of all it doesn’t go on any tax return. The fees are high but the tax incentives are generous,” he said.
One of Threlfall’s favourite EISs is Acamar Films, a family-owned production company based in Camden, north London, which made the children’s television programme Bing. “I’ve invested three tranches so far and my £60,000 is now worth £67,700, which is terrific. However, it would not be unreasonable to expect a three to five times return if the firm is taken over.”
He also backed Zero Carbon Farms, which grows food in a disused air raid shelter 33m underground in Clapham, south London. It produces small leaf crops such as coriander, dill and pea shoots.
He invested £10,000 but said that the “jury is still out” on the success of his investment. “The downturn in the hospitality sector and increase in electricity prices has impacted sales but the social and sustainability trends support agritech businesses.
“It takes longer than you think to turn your investment into profit. You need at least five years. You can’t expect a Cazoo experience every time, where a company gains unicorn status [a valuation of £1 billion] in a very short time.”
Threlfall said he lost money investing in the West Berkshire Brewing company, which was bought out after going into administration.
