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With higher rate taxes going up and pension tax relief going down, tax-efficient investment products are becoming an increasingly important part of retirement planning. However, given HMRC's expectation that anti-avoidance will be on the rise, many of these investments will not be around in future tax years. In essence, we have a situation where it is 'buy now, while stocks last'!

Products like Venture Capital Trusts (VCTs) can offer some very attractive tax breaks, including 30% tax relief upfront on investments up to £200k if held for five or more years. There is also the added bonus that dividends are free of income tax, as are the capital gains.

Although the incentives are enticing, the problem with traditional VCTs is that they were set up to invest in high risk, start-up companies so an investment could end up being worth double, or nothing. However, over time, they have become much more sophisticated. These types of VCT start-ups include companies which buy and lease specialist equipment in high demand, as well as those supplying services to established organisations.

Another problem with VCTs in the past has been their ‘illiquidity' when investors want to sell them, often resulting in the redemption values being suppressed due to lack of demand. Most of the ‘new age' VCTs have a planned exit strategy, which usually entails a wind up after five years, whilst still qualifying for 30 per cent tax relief. While certain VCTs have been making solid returns for investors on top of their tax breaks, if your investment does not gain in value, the tax relief alone is worth the initial outlay, as the example below shows.

EXAMPLE

For a £100,000 investment in a VCT, £30,000 can be kept in cash and £70,000 invested in a qualifying company. There is upfront tax relief of 30%, so the net cost of the investment is £70,000. The current rules are that the investment must be held for a minimum period of five years. Of course the value of the investment has the potential to decrease as well as increase; however, from a tax perspective, the investor has effectively recouped £30,000 that would otherwise have gone to the tax man.

The tax breaks relating to VCTs mean that overall returns compared to identical non-VCT investments would need to be higher (by the amount of tax relief achieved) in order to achieve the same result.

Given the Inland Revenue's concern that these types of schemes are being sold for their generous tax breaks alone rather than to nurture start-up companies, it is unlikely that certain types of VCT will be around by April next year, so we are urging investors to take investment advice on the opportunities available while they can.

This summary is for information only regarding the tax treatment of VCTs. It is in generic form and is not intended to provide investment advice which Target Chartered Accountants is not authorised to give. If you would like to receive more information about specific VCT investments, please contact a member of the Target Financial Management team, a group company which is authorised to give investment advice by the Financial Services Authority.