Extracting profits from a business tax-efficiently with a VCT

The Challenge

Raj is a design consultant with his own limited company. To be tax-efficient, Raj pays himself a salary up to the tax-free personal allowance of £12,570, and he tops up his income by paying himself an annual dividend of £50,000. However, he is aware that paying himself through dividends has become less tax-efficient down the years. When the dividend allowance was introduced in 2016, the first £5,000 of dividend income received was tax-free. However, the allowance was lowered to £2,000 in the 2018/2019 tax year, and cut to £1,000 in the 2023/2024 tax year. In the 2024/25 tax year, the dividend allowance has been halved again, so only the first £500 of dividend income received is free from tax. Raj’s dividend payment is therefore taxed as follows:

• He can claim a £500 tax-free allowance
• The next £37,200 is taxed at 8.75%
• The remaining £12,300 is taxed at 33.75%
• This leaves Raj with an income tax bill of £7,406.
• It means that withdrawing £62,570 from his limited company annually leaves him with just £55,163 after tax.

The Solution

Raj discusses his situation with his financial adviser, who talks through the benefits and the risks of investing in a Venture Capital Trust (VCT). His adviser tells Raj that if he made an investment of £24,687 into a VCT, he would be able to claim 30% income tax relief on his investment, which equates to £7,406, provided Raj holds his VCT shares for the minimum five-year holding period.

VCTs often target a dividend, so Raj can expect to receive an annual tax-free income from his investment. VCT dividends are completely tax-free and there’s no HMRC requirement for Raj to declare them on his tax returns. As a result of his investment, Raj effectively wipes out his income tax liability, giving him an annual income of £62,570 plus a tax-free income from the VCT.

Investor’s capital is at risk.
For simplicity, this illustration does not take into account investment growth or charges for the investment. It is based on the current tax rules and personal allowances as at September 2024, which could be subject to change and depend on individual circumstances. Tax reliefs depend on a VCT maintaining its qualifying status and target returns may not be guaranteed.

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