SJP’s Tony Mudd questions which clients would benefit from holding their VCTs in an Isa
The saying “if it seems too good to be true it probably is” applies to many things in life generally, not least within financial services. HM Revenue & Customs uses it to help taxpayers identify evasion techniques they are offered and perhaps considering.
So, what are we to make of the recent news that Octopus Investments is enabling people to invest in venture capital trusts through Isas for the first time?
On the face of it, a very innovative and potentially positive thing for clients and advisers alike. However, is this new “opportunity” all it seems, or is it just another case of too good to be true?
The announcement was heralded as a method of “cracking the small business investment market and opening it up to more people”, with the strong inference being it would make VCTs significantly more attractive. But I am not convinced.
All advisers and indeed most clients are aware of Isas, now available in a myriad of forms, which have had a significant impact on the saving habits of the nation.
Most advisers and some clients will be aware of VCTs, which have taken increasing funds under management over the last few years and had a very positive impact on funding growth in UK PLC.
The question is what, if any, benefit combining the two will bring? That is, outside the cynical view (to which I obviously do not subscribe) that it will enable advisers to give advice without the need for new money.
Combining the two does not change the investment position in respect of dividends and capital gains tax, which, subject to the VCTs being held for five years, will be identical. The differences, on the other hand, are stark.
Isas do not afford the investor any form of upfront tax relief, whereas Isas holding VCTs provide relief against income tax up to 30 per cent of the amount subscribed, subject to strict rules. In terms of the underlining investments, Isas mainly hold funds in cash or collectives, such as unit trusts. Compare this to VCTs which, while listed companies themselves, actually invest in a range of small unquoted trading companies.
The difference in client risk profile between the two is considerable and, by definition, will have a significant bearing on the type of client for whom it is suitable. So, who are the appropriate clients for Isas holding VCTs?
- Those with modest savings, up to the Isa limits, should stick to conventional Isa investment mediums
- Those with large amounts to invest but unwilling to accept high risks should stay with conventional collectives
- Those with larger sums and higher attitudes to risk should go direct into VCTs. Isas provide no additional benefit
- Clients who have accumulated significant funds in their existing Isas and suddenly have a higher attitude to investment risk may be suitable.
Flippant? Perhaps. However, the justification for the change in investment risk could be crucial. The Income Tax Act (ITA) 2007, s.261(3) states that no income tax relief can be given if the VCT shares were not acquired for a genuine commercial purpose, or were acquired as part of a scheme or arrangement the main purpose (or one of the main purposes) of which is the avoidance of tax.
When it comes to CGT on the disposal of VCT shares, the CGT exemption requires the disposal to be “qualifying” and one of the qualifications is that when the individual acquired the VCT he or she must have done so for a bona fide commercial reason, and not as part of a scheme in which one of the main intentions was tax avoidance (Taxation of Chargeable Gains Act 1992, s.151A).
Whether HMRC will take this view now or only as millions flow into Isas, with the subsequent cost to the Treasury, is one question.
Perhaps a more pertinent one for advisers is whether their clients will thank them for increasing their investment risk profile for tax benefits that may not materialise or, worse still, need to be repaid. Too good to be true? You decide. Adviser beware? Absolutely.
Tony Mudd is divisional director, development and technical consultancy, at St James’ Place