Extracting money from a business

It may be advantageous for small business owners to take out surplus money that’s building up in their business. Changes to dividend taxation mean small business owners and entrepreneurs who pay themselves through dividends could face higher tax bills and lower take-home earnings.

This tax-planning scenario explains how clients can use a Venture Capital Trust (VCT) to extract surplus money from a business.

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About this planning scenario

Vijay wants to make a tax-efficient extraction from his small business

Vijay is an independent IT contractor. Because he works as a consultant for a number of different companies, he has established a limited company.

Vijay chooses to pay himself a combination of a salary of £12,570 (within his National Insurance Contribution threshold) and a dividend of £39,700. He owes £3,386 in tax, meaning after tax, he’ll be left with £48, 884 in available cash.

Vijay also pays into his pension and chooses to invest in some new technology for his business. But he’s still left with surplus money building up in his business. There’s an opportunity cost to not better utilising this money, but there may also be other tax implications in the future if it continues to build.

Because of this, Vijay is keen to extract an additional dividend from his company but is wary about the extra tax he would owe.

Vijay’s financial adviser suggests investing in 
a VCT

Vijay talks to his financial advisor, who makes an assessment based on:

• His risk profile
• His investment time horizon: more than five years
• His attitude towards investing in smaller companies

Given Vijay’s goal of extracting surplus money tax efficiently, his adviser suggests that he pay himself an additional £50,000 dividend and invest it into a VCT, holding the investment for at least five years.

With a VCT, Vijay can claim up to 30% income tax relief on up to £200,000 invested in any single tax year – provided he holds his VCT shares for at least five years. Vijay can also benefit from tax-free dividends and no capital gains tax to pay when he sells the shares.

Tax benefits of investing dividends in a VCT

Here’s an example that shows how a small business owner can take advantage of the tax benefits associated with investing in a VCT to offset some of their dividend tax bill.

Note: Tax rates and allowances are correct for the tax year 6 April 2023 – 5 April 2024. For purposes of this illustrative example, we have assumed no gain or loss on investments, and it does not take into account any initial fees or ongoing charges that will be incurred. VCTs are high risk and inherently different from pensions and ISAs. When clients choose to sell VCT shares, they are often sold at a small discount to the value of their underlying net asset value, so the impact of this should also be considered when assessing any specific products. Please note, after selling shares in a VCT, it is not possible to claim tax relief on new shares bought in the same VCT within six months of the initial sale.

Before investing in a VCT, investors should read the product prospectus and Key Information Documents (KID).

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