Lindsey Wicks looks at some of the changes to the seed enterprise investment scheme, enterprise investment scheme and venture capital trust rules.
The Treasury launched a consultation Financing growth in innovative firms (www.gov.uk/government/consultations/financing-growth-in-innovative-firms) on 1 August 2017 as part of its wider Patient Capital Review (www.gov.uk/government/publications/patient-capital-review) that ran from 23 January 2017 to consider how growing innovative firms could access the long-term or ‘patient’ finance that they need to scale up their business. Part of the consultation considered the role of the current tax rules in supporting the investment of long-term capital. The consultation outcome was published on 22 November 2017 alongside the Autumn Budget and provides the background to the various changes that were announced.
More investment for knowledge-intensive companies
As a result of the above consultations, it was announced at the Autumn Budget 2017 that, from 6 April 2018, the following changes would apply to encourage more investment in knowledge-intensive companies:
- the annual enterprise investment scheme (EIS) investment limit that an individual can invest is doubled from £1 million to £2 million, as long as any amount over £1 million is invested in one or more knowledge-intensive companies; and
- the annual limit on EIS and venture capital trust (VCT) investment that knowledge-intensive companies can receive is doubled from £5 million to £10 million (with the company lifetime limit remaining at £20 million for knowledge-intensive companies).
The annual limit that individuals can invest in a VCT is unchanged at £200,000 as it is the VCT that makes investments in other companies (including knowledge-intensive companies).
A knowledge-intensive company must satisfy various conditions concerning:
- the proportion of operating costs expended on research and development (R&D) or innovation;
- the expectation that the greater part of the business will derive from the exploitation of intellectual property or the creation of new products, processes, or skills from using the intellectual property; and
- the proportion of employees holding a relevant higher education qualification that are directly involved in R&D or innovation activities.
The operating costs conditions are amended for knowledge-intensive company shares issued and investments made on or after 6 April 2018 for companies that have been trading for less than three years at the time of the investment.
The concept of a knowledge-intensive company was first introduced into the EIS and VCT rules by Finance (No 2) Act 2015 and is relevant when considering:
- the lifetime limit on capital that a company can raise under the seed enterprise investment scheme (SEIS), EIS and VCT rules;
- the number of employees that a company can have and qualify for EIS and VCT investment;
- the age limit for the company; and
- the annual limit on raising EIS and VCT funds.
In terms of the age limit rules, another change will apply for knowledge-intensive company shares issued and investments made on or after 6 April 2018. Knowledge-intensive companies will be able to use the date when their annual turnover first exceeds £200,000 rather than the date of the first commercial sale to determine the start date of their initial investing period.
Given that it is these knowledge-intensive companies where the perceived investment gap lies, a consultation on the development of an EIS knowledge-intensive fund was announced at the Spring Statement 2018 (www.gov.uk/government/consultations/financing-growth-in-innovative-firms-enterprise-investment-scheme-knowledge-intensive-fund-consultation).
Risk-to-capital condition
The consultation highlighted a significant amount of what were considered to be low-risk ‘capital preservation’ investments being made under the EIS, VCT, and SEIS rules. To counter this, a principle-based test applies to investments made on or after a date to be set by regulations that will be no earlier than 15 March 2018 (which is still awaited at the time of writing).
The risk-to-capital condition (known as the risk-to-capital requirement for VCTs) is met if, having regard to all the circumstances existing at the time of the issue of the shares (or relevant holding for VCTs), it would be reasonable to conclude that:
- the issuing company (or relevant company for VCTs) has objectives to grow and develop its trade in the long-term; and
- there is a significant risk that (for the investing company in the case of a VCT) there will be a loss of capital of an amount greater than the net investment return.
The subjective nature and imprecise wording of this test has received some criticism, but the test remained unchanged during the Parliamentary process. Appendix A of Financing growth in innovative firms: consultation response (https://tinyurl.com/PCR-Consultation-Response) published on 22 November 2017 was dedicated to explaining the test and draft guidance on the test was published in HMRC’s Venture Capital manual at VCM8500 on 4 December 2017. Those seeking advance assurance concerning money being raised under the SEIS, EIS and VCT regimes will have experienced the fact that advance assurance will not be given on or after 4 December 2017 (the date of the publication of the guidance) in cases where HMRC considered that this test would not be met.
Further changes to the VCT rules
The VCT rules were subject to change in 2015 to encourage investment in riskier early stage firms. The consultation highlighted further changes that could be made to the rules, but also recognised that some of the existing conditions were unnecessarily restrictive. The changes made in response to the consultation don’t affect how investors invest in VCTs, but they will affect the rules concerning the investments that VCTs make.
Practical Tip:
While investments in EIS and SEIS companies and in VCTs attract tax relief meaning that tax advisers need to be aware of the tax rules, they should take care not to stray into giving investment advice unless they are authorised to give financial advice.
