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  • Background – venture capital tax reliefs

    The Chancellor really set his stall out in terms of where he, and presumably the Government, see future economic growth. In the middle of quite a gloomy outlook for the economy and attempts to broaden the tax base generally, Phillip Hammond announced a relative financial boon for venture capital and particularly so called ‘knowledge intensive’ businesses.

    So why this waterfall of venture capital tax reliefs? This is partly due to the Patient Capital Review which has been going on for the last 12 months or so.

    This Treasury-led review, identified barriers to the access of long-term finance for growing firms.

    Below, we will break down the measures that will take place with immediate effect of by 6 April 2018. We will also discuss future measures and consultations that were also announced.

    Effective immediately / April 2018

    Risk to capital condition – EIS and VCT

    This measure came as no big surprise. Indeed, anecdotal evidence seems to have been that HMRC has already being operating this policy informally for a period of time!

    The Budget set out that the Government will to change the EIS, SEIS and VCT rules to ensure that they are more narrowly focussed on higher risk, Intellectual property rich companies. This is following concerns that investment providers are pulling together investments that are primarily focussed on “capital preservation” for their investors.

    This does not seem objectionable as the venture capital tax reliefs provided to EIS investors are very attractive. The justification for these reliefs is that they are supposed to be investments in high growth, and therefore high risk, businesses. This seems to act as a way of re-aligning that position.

    The legislation will be amended, seemingly, by introducing a new “risk to capital” provision. This will be introduced for any such investments made from 6 April 2018 onwards.

    The provision which will contain two tests:

    1. Firstly, it will include a provision that mirrors the existing “growth and development” condition already present in the EIS and VCT (however, not the Seed EIS) legislation; and
    1. Secondly, there will be a requirement for the investor to be under a significant risk that they could lose capital in excess of his net return. It should be noted that the ‘net return’ will not only include income and / or capital growth but also any up-front income tax relief

    HMRC has set out its stall and will have the discretion to refuse to provide clearances in respect of advance assurance applications if the investee company appears to fall foul of the new conditions from 1 December 2017.

    Clearly, the clearance is an important ‘marketing tool’ for those going to the market to raise capital. As such, this change could have deleterious consequences for those wishing to raise capital.

    Of course, these tests involve a degree of subjectivity. Clearly, one will need to form a ‘reasonable’ view as to whether a proposed venture capital investment has indeed been structured so as to provide its investors with a low risk return.

    With this in mind, the Government / HMRC has promised to provide guidance. We are told that this guidance will include a list of factors that HMRC will take into account when assessing whether the risk to capital condition is met. Bearing in mind the patchy quality of recent HMRC guidance, it remains to be seen as to whether this will be much practical use.

    This is due to be published on 1 December 2017.

    Increased investment limits for knowledge intensive companies – EIS and VCT

    When viewed as a whole, the changes to venture capital schemes can be seen as a redistribution of tax relief rather than a restriction. It seems that what has been taken away from ‘capital preservation’ schemes with the left hand will be given to knowledge intensive companies with the right.

    This is because the Government has announced an increase in the limits for investors and investments in so called ‘knowledge intensive’ companies.

    These changes can be summarised as follows:

    • There is an increase in the maximum annual investment that can qualify for income tax relief and the capital gains tax exemption for EIS investors. This limit is increased from £1m to £2m;
    • There is also a ‘doubling’ in the annual capital raise for both EIS and VCTs that invest in ‘knowledge intensive companies from £5m to £10m;
    • Where the company is a ‘knowledge intensive company’ the lifetime limit is set at £20m. This limit will remain unchanged;
    • A knowledge intensive company will also be able to choose whether the 10-year period (setting a limit on the age of such investee companies) commences on the date:
    1. the company’s first commercial sale; or
    2. on which the company’s turnover exceeded £200,000

    Of course, you will see if I have used the description ‘knowledge intensive’ rather liberally over the last few pages. What does this actually mean?

    Well, the test as to whether a company is “knowledge intensive” in the VCT is rather detailed and not, whether this comes as a surprise or not, not particularly straightforward to apply.  The relevant company must be able to demonstrate that it satisfies certain conditions relating to:

    • the amount of R&D expenditure over the last three years, and
    • that either it employees a relevant proportion of skilled and qualified employees or is engaged in innovative activities.

    Changes announced in the Budget that there would be some amendment to the qualifying conditions for companies that were less than three years old.

    It should be noted that these measures, which subject to being granted state aid approval, will apply to investments made on or after 6 April 2018.

    Relevant investments – EIS and VCT

    It was announced that the Government will amend the definition of a ‘relevant investment’ to ensure that all investments, including risk capital investments made prior to 2012, will be included in the lifetime funding limit for companies receiving investment under tax advantaged venture capital schemes.

    As partially referred to above, the limits are £12 million for most companies and £20 million for knowledge-intensive companies.

    It is interesting that the 2012 cut off was brought in by the new rules in FA2012 to avoid ‘retrospective taxation’. It does go to show the Government is much more relaxed about retrospective measures these days!

    Future changes / developments – venture capital tax reliefs

    Advance assurance

    At the Budget, HMRC essentially published the responses to a previous consultation with the anticipated next steps.

    It was clear that those who responded felt that the existing advance assurance ‘service’ was valuable. It should be noted that the advance assurance is a statutory requirement, of course! However, HMRC acknowledge that their ‘customers’ wish to retain the service where seeking to raise an investment.

    This is not a surprise as this will be a key marketing tool for those going to market. The quid pro quo for a ‘risky’ investment is, as mentioned above, the vsluable tax relief.

    Clearly, HMRC are feeling the pressure in respect of resourcing this obligation. It states that HMRC currently provide an assurance for around 70% of all applications without query.

    In respect of the balance, two thirds of the remainder are approved following the provision of additional information.

    Perhaps surprisingly, HMRC state that their figures suggest that around 50% of companies receiving an advance assurance do not go on to raise funding!

    As such, HMRC are looking at ways to reduce this ‘unnecessary demand’ on their resources. Essentially, it appears there will be further consultation in this area around improving the process.

    EIS Innovation fund

    A short point that one of the suggestions / recommendations born out of the Patient Capital Review was the creation of a ‘knowledge intensive’ EIS fund structure.

    It is expected that there will be a consultation on this in 2018.

    Conclusion – Venture capital tax reliefs 

    It is clear that venture capital reliefs, and in particular those that are ‘knowledge intensive’ are very a la mode for the Government. The direction of travel is to seek to widen the tax base by bringing immovable property in to the CGT charge, attempting to ween the economy off bricks and mortar.

    Instead, the Budget has set out its stall to encourage growth and innovative companies in the UK and, one assumes, make the UK a destination for entrepreneurs who are interested in setting up such ventures by offering attractive venture capital tax reliefs.

    Whether this is a success, time will surely tell.

    If you have any queries regarding the Budget changes to venture capital tax reliefs or venture capital tax reliefs in general then please get in touch.