This analysis is part of the Lexis®PSL Tax team’s summary of the Autumn Budget 2017. Some of the links require a LexisPSL subscription. If you are not a subscriber, you can take a free trial here.
Venture capital schemes—risk to capital condition
Following the consultation Financing growth in innovative firms (to which a response document has been published today), the government has announced its intention to include a new condition for relief in the Enterprise Investment Scheme (EIS), Seed Enterprise Investment Scheme (SEIS) and Venture Capital Trust (VCT) regimes to ensure that the relief is better targeted at growth investments and to exclude ‘capital preservation arrangements’.
Taking a different approach to the past (where it has excluded particular types of low-risk investment such as energy generation), this measure takes a ‘principled approach’ requiring all relevant factors to be taken into account in determining whether, on a ‘reasonable view’:
- the investee company has objectives to grow and develop
- there is a significant risk of a loss of capital, where the amount of the loss could be greater than the net return to the investor (which includes the tax relief and income and capital growth)
A non-exhaustive list of factors to be taken into account will be provided in the legislation. The response to consultation suggests it will include:
- the nature of a company’s ownership structure, such as being controlled by fund managers as nominees for investors—with the government identifying arrangements where companies are set up by advisers as a particular target, however the examples given do not indicate why investments into companies affiliated with fund managers are necessarily considered to be less risky, and
- whether income from an asset forms a substantial part of the trade
while making it plain that the presence of any given factor does not necessarily cause a failure of the condition. The document also indicates that the use of special purpose vehicles or outsourcing of staff where they are common in the industry (such as in film and media production companies) will not necessarily prevent the condition from being met. The documents published do not indicate whether a factor of tax motivation will be included in that list.
Legislation will be included in FB 2018. The documents published contain conflicting information on the effective date: the OOTLAR and the response to consultation state that it will have effect for investments made on or after Royal Assent of FB 2018, but the TIIN gives a specific date of 6 April 2018 (in either case, subject to obtaining state aid approval).
The government has stated that it will issue detailed guidance on the new measure shortly after the publication of FB 2018 and that HMRC will cease to give advance assurance for investments that appear not to meet the condition from that date. Since advance assurance is not a condition for relief to be obtained, it will still be possible for an individual to obtain relief on an investment made after the guidance is issued (but before the effective date) but the issuing company will not be able to use the marketing advantage of stating that advance assurance has been obtained.
Venture capital schemes—encouraging investments in knowledge-intensive companies
Measures were included in Finance (No 2) Act 2015 to enhance relief under the EIS and VCT schemes where investments are made into Knowledge Intensive Companies (KICs). Following the consultation Financing growth in innovative firms, the government has announced further measures to encourage investments into such companies and to loosen some of the conditions for KICs, specifically:
- increasing the individual investment limit for EIS relief to £2 million where any amount over £1 million (the usual limit) is invested in KICs
- increasing the annual investment limit (in both the EIS and VCT regimes, being the cap for the amount of risk finance investment raised over the past 12 months) for a KIC to £10 million (doubling the standard limit of £5 million)
- changing the permitted maximum age rules (in both EIS and VCT regimes, being the rules that ensure the reliefs are targeted to ‘young’ companies) for KICs so that the 10 year initial investing period can start at the point the annual turnover exceeds £200,000 rather than the first commercial sale (at the choice of the KIC), and
- amendments to the operating costs condition (in both the EIS and VCT regimes) so that it can be met by a company that has been in existence for less than 3 years (the existing rules require a KIC to have spent certain percentages of its operating costs on research and development activity over a three year period prior to the investment)
The measures will be included in FB 2018 and take effect for investments made on or after 6 April 2018 (subject to obtaining state aid approval).
Encouraging more high-growth investment through VCTs
A number of additional measures are to be introduced to ensure that the VCT regime is targeted to high-growth companies.
Three substantial changes are to be introduced:
- with effect for funds raised in an accounting period beginning on or after 6 April 2018, there will be a new condition for VCT approval that 30% of the funds raised will have to be invested into qualifying holdings within 12 months of the end of the accounting period in which the funds were raised
- the 70% qualifying holdings condition will be increased to 80% with effect from accounting periods starting on or after 6 April 2019, but the relaxation under which a disposal of a qualifying holding (held for at least six months) wholly for cash consideration is, broadly, disregarded for six months following the disposal is being extended to 12 months for disposals on or after 6 April 2019, and
- in order to be a qualifying holding in an investee company, a loan must, with effect from Royal Assent of FB 2018, be unsecured and must not provide more than a commercial rate of return on the principal, where a return of under 10%, averaged over 5 years, will be considered commercial (ie that limit is a safe harbour, but a higher return could still be classified as a commercial return in the right circumstances)
Certain grandfathering provisions will come to an end with effect from 6 April 2018, namely:
- ITA 2007, Sch 2, para 69, which prevents the ‘no guaranteed loans’ requirement in ITA 2007, s 288 from applying to moneys raised before 2 July 1997
- ITA 2007, Sch 2, para 81, which allowed moneys raised before 17 March 1998 to continue to be used in property development, farming, woodlands, hotels and nursing homes (when they otherwise had been classified as excluded activities)
- FA 2007, Sch 16, para 3(6)(b), which allowed companies that did not meet the maximum number of employees test to continue to be qualifying companies if the investment was made prior to 6 April 2007
- FA 2008, Sch 11, para 12(b), which allowed moneys raised before 6 April 2008 to continue to be used in shipbuilding, coal and steel production (when they otherwise had been classified as excluded activities)
- ITA 2007, Sch 2, para 70, which allowed moneys raised before 2 July 1997 to be excluded when considering whether the proportion of eligible shares requirement in ITA 2007, s 289 was met in relation to a given holding
- F(No 3)A 2010, Sch 2, para 6(2)(b), which allowed moneys raised before 6 April 2011 to be excluded when considering whether the VCT met the 70% eligible shares condition in ITA 2007, s 274
The measures will be included in FB 2018 (subject to state aid approval).
Venture capital schemes—relevant investments
A lifetime limit on the total amount of risk finance investment a company may have was introduced by Finance (No 2) Act 2015 to the EIS and VCT regimes of £12 million for most companies (increasing to £20 million for KICs). When it was introduced it relied on the definition of ‘relevant investments’ to determine the types of investment included in the lifetime limit, which had the effect (as a result of the various changes that had been made to that definition as used for the purposes of the annual limit since 2007, with associated transitional provisions) of excluding some investments made at earlier stages. This was an unintended effect and the definition of relevant investment (presumably only for the purposes of the lifetime limit) will be amended to include all risk finance investments, whenever made. The measure is also expected to apply for the purposes of Social Investment Tax Relief.
The measures will be included in FB 2018 and take effect for investments made on or after 1 December 2017.
See OOTLAR (para 1.10) and TIIN: Venture Capital Schemes: relevant investments.
VCTs—limiting the effect of anti-abuse provisions on commercial mergers
Following the introduction of an anti-abuse measure to prevent individual investors refreshing income tax relief on investments into VCTs by disposing of VCT shares and reinvesting the proceeds in new shares (either by bed and breakfasting or through the merger or restructuring of the VCT), the government is now making a retrospective change to the measures (with effect from 6 April 2014 — the date the original measure came into effect), to ensure that the measure applies as intended and does not capture commercially driven mergers.
Legislation will be introduced in FB 2018 to amend the parts of ITA 2007, s 264A that deal specifically with mergers or restructurings of VCTs so that it does not apply where:
- the merger is more than 2 years after the date of subscription of the shares
- the individuals subscribing could not reasonably be expected to know that the merger or restructuring was likely to take place (even if it is within 2 years), or
- obtaining a tax advantage is not one of the main purposes of the merger (again even if it is within 2 years)
- Advance assurance: on 1 December 2017 the government will publish its response to the 2016 consultation Tax-advantaged venture capital schemes – streamlining the advance assurance service (for which see News Analysis: Streamlining the tax-advantaged venture capital schemes). See: OOTLAR (para 2.9)
- EIS funds: the government will consult in 2018 on a new knowledge intensive EIS fund structure with further incentives that would enable the use of capital over a long period (as part of the government’s response to the Patient Capital Review). See: OOTLAR (para 2.10)
- SEIS: the government will continue to monitor whether the SEIS regime is contributing to valuation bubbles in certain sectors. See: Consultation response: Financing growth in innovative firms (para 3.12), and
- EIS funds and VCTs: the government will continue to monitor whether the EIS funds and VCTs are causing artificial inflation of share prices and the use of structures involving liquidity preferences, taking action against behaviours against the spirit of the schemes if necessary. See: Consultation response: Financing growth in innovative firms (para 3.19)
- SUMMARY OF KEY ANNOUNCEMENTS AND BACKGROUND
- BUSINESS AND ENTERPRISE
- INCENTIVISED INVESTMENT
- EMPLOYMENT TAXES AND SHARE INCENTIVES
- REAL ESTATE TAXES
- TAX ADMINISTRATION AND AVOIDANCE
- ENERGY AND ENVIRONMENT
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