When 30% tax back is not enough

It’s clear that the politicos don’t want us sitting on cash. They want it spent. If not squandered on the High Street, then invested in the markets. Our leaders may operate in a ham-fisted way, but it rarely pays to fight them.

The Fed’s new round of QE has sent the markets flying – our bets on commodities and gold are romping home. And it’s why I’ve been telling you about how you can invest your money with the taxman on your side.

I wrote a couple of days ago about the Enterprise Investment Scheme (EIS), outlining some pretty generous tax rebates for start-up investors.

I know that most of you probably aren’t in the throes of starting a business, so you may be tempted into a similar scheme with the same tax advantages – Venture Capital Trusts.

Today I’ll run through the idea behind the Venture Capital Trust (VCT) and why there is a much better way to invest in budding businesses.

Get 30% of your tax back

A VCT invests in small, unquoted companies. It’s a kind of cross between a private equity fund and an investment trust. When it’s launched it raises funds allowing investors some great tax breaks. That’s because the government wants your cash invested in small businesses.

After they’ve raised the money, the VCT’s shares are traded on the stock market. You can get more information about the current crop at trustnet.

If you’re in the new higher-earner bracket and facing 50% tax on earnings, or if you’re only paying 40%, you may want to claw some of it back. So it’s hardly surprising that interest in VCTs has gone through the roof.

Martin Churchill, editor of the Tax Efficient Review, predicts £450m could be invested this tax year, up from £350m last.

As a higher rate payer, you can get 30% income tax relief. So if you invest £7k, the taxman stumps up £3k. You can invest up to £200k this way giving you a £60k tax break. Dividends won’t be taxed and no capital gains tax either.

Sounds good? Maybe, maybe not. If you’re thinking that my grandstanding of EIS automatically makes me an advocate of the VCT, then you may be disappointed. Though the tax advantages look similar, there’s a big difference.


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Would you punt your cash on a stranger?

I showed you how you can use an EIS to get some great tax breaks for investing in a start-up. And that may be a smart move.

But it’s a very different affair if you’re punting on a stranger. I would think that a start-up where you don’t know the directors is piling risk on top of risk. With a VCT, you hand control of the investment to the VCT fund manager. You’ve got no idea what’s going to happen.

And my hunch is borne out in the reported returns from VCTs. They can be incredibly good, or incredibly bad. From what I can see there’s little way of predicting how your fund will fare.

And then look at the fund management fees. An entrance fee of around 5% and annual fees around 2% or 3% may eat into those tax breaks.

And selling up isn’t all that straightforward either. You’ll lose the 30% from the taxman if you sell before five years. And bearing in mind the focus is on tax-free dividends in the future, capital performance can be pretty ropey.

If you do still feel like you want to invest in VCTs, it would be wise to contact an independent adviser. Somebody like Martin Churchill, of the Tax Efficient Review could offer you some advice. And do your homework- find out as much as you can about the fund manager and the investments he’s going to make with the VCT.

But I think there is a far better way to invest for high risk and high reward.

Go with the man you know

Tom Bulford is not a man who likes to entrust his money to a stranger either. And especially not a fund manger. As he pointed out this week – ‘fund managers simply destroy value. 28% of retail investment funds run by banks have, over the last ten years, deducted more in fees than they have delivered in returns. It’s outrageous!”

So who do you trust then? Well there are a few characters that Tom keeps a close eye on. He has just sent me over a story that is going in the latest issue of Red Hot Penny Shares. It’s about a small oil group leading a new oil rush in the States. But crucially:

“It has the backing of one of the most successful oil industry investors of recent times. When this oil tycoon backs a business I take notice. In 2004 shares in his last venture started trading at 28p. Five years later it was bought out at £12.50 per share!”

Now I don’t want to give away the name of this oil tycoon – Tom wouldn’t be best pleased. But when it comes to pursuing a high risk and high reward investments, it strikes me as a far better idea to back a character like this. Don’t leave yourself at the mercy of a fund manager who may struggle to justify his fee.

If you’re interested in reading about this oil tycoon. Or Tom’s other tip, then click here to find out more about Red Hot Penny Shares. It’s a great issue this month.

• This article was first published on 5 November in the free investment email The Right side. Sign up to The Right Side here.

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