The Spring Statement 2018: Entrepreneurs’ Relief and the Enterprise Investment Scheme
For twenty years we have had a Budget falling in spring with a second update later in the year, most recently in the form of an Autumn Statement.
Over time two ‘fiscal events’ in a year led to a confusing proliferation of consultations, responses and draft legislation. In future we are promised a single fiscal event, with the main announcements coming in the Budget which has been pushed back to the autumn.
So as expected the Chancellor of the Exchequer’s first Spring Statement on 13 March made no new announcements of immediate tax changes, no new spending commitments and no new policy announcements.
Despite the absence of concrete measures, the Treasury published several consultations including one on Entrepreneurs’ Relief and another on the Enterprise Investment Scheme.
Having been introduced ten years ago, the basics of Entrepreneurs’ Relief will be familiar to most advisers. It reduces the rate of capital gains tax applying to qualifying disposals of business assets, including shares in trading companies, from 20% to 10%, subject to an individual lifetime limit of £10 million.
Such a generous relief is underpinned by small print including the requirement that the seller must hold 5% or more of the ordinary share capital and voting rights in the company, be an officer or employee of the company, and have fulfilled these conditions throughout the 12 months to the date of disposal.
One concern highlighted in responses to the Treasury’s Patient Capital Review in 2017 was that issuing new share capital to raise funds might result in the ‘dilution’ of existing shareholders below the crucial 5% threshold and therefore forfeit their ability to claim Entrepreneurs’ Relief on a future disposal of their shares.
Those impacted by the potential loss of this valuable relief might be deterred from seeking external funding for growth or attempt to grow their business using their more limited personal resources, or perhaps sell up completely and exit the business, thereby denying what could be an even more successful company the benefit of their energy and experience.
The Government’s proposal in the consultation document is that such shareholders will be able to elect to be treated as disposing and reacquiring their shares immediately before dilution of their shareholding below the 5% threshold. Moreover, rather than pay the capital gains tax liability that would arise – and for which there would be no cash proceeds – they will be able to claim to defer the liability until an actual disposal of the shares.
Having banked Entrepreneurs’ Relief on the growth in value of the shares to the date of dilution, any further gains over and above the value at the date of dilution will then be subject to capital gains tax at the usual 20% rate.
Anticipating avoidance opportunities that might arise, the consultation proposes that it will be a condition for election that the issue of shares by the company be part of a commercial scheme or arrangement which has as its main purpose or one of its main purposes, the obtaining of capital as new consideration subscribed for the issue of new shares.
The new rules as outlined would exclude claims for Entrepreneurs’ Relief on gains arising from associated disposals, where a shareholder owns an asset, typically a property, used in the business. In these instances, while there will be the ability to elect for a deemed disposal of the shares immediately before dilution, and secure Entrepreneurs’ Relief on the growth to that point, there will be no ability to claim Entrepreneurs’ Relief on the ultimate disposal of the asset since at that point the individual will not qualify for Entrepreneurs’ Relief.
If introduced as outlined, the measure will take effect for events resulting in a dilution of shareholdings from 6 April 2019 onwards, meaning tough luck for anyone impacted over the coming year. Potentially, those impacted might have one eye on the clock and decide to push back their fundraising until they can secure the new treatment, particularly in the latter part of the 2018/19 tax year when the new measures are close to taking effect.
While this measure is welcome, better still would be to have dropped the 5% requirement and cut out the complexity of the proposed new rules, after all, the complexity of the UK’s tax system is a recurring complaint. In fact, the requirement to hold 5% or more of the shares has already been removed for those who acquire their shares under an Enterprise Management Incentive option scheme. So why not do this?
The driver behind the consultation document’s more convoluted proposal appears to be cost. Entrepreneurs’ Relief was introduced with a view to encouraging investment but the costs have far outstripped Treasury predictions and is anticipated to cost the Exchequer £2.7 billion in the 2017/18 tax year. As such, while the Chancellor aims to remove the disincentive for entrepreneurs to seek outside investment, he is minded to do it in a way that keeps tight control on the costs of this relief.
The consultation runs until 15 May 2018.
Enterprise Investment Scheme
The Chancellor announced in the 2017 Autumn Budget a plan to unlock £20 billion of investment over the next decade to further boost the UK economy.
Building on that action plan, the Chancellor announced in his Spring Statement a consultation on the Enterprise Investment Scheme (“EIS”) and the difficulties faced by knowledge-intensive companies in securing growth capital.
EIS was launched 25 years ago to encourage investment into new trading companies. Under the current scheme, investors benefit from income tax relief of up to 30% of their investment, the potential to defer capital gains tax on gains arising in the year of investment, and the exemption from capital gains tax on the future disposal of EIS shares.
The Government take the view that in future, EIS and other venture capital schemes should become increasingly targeted at innovation and growth and we have seen steps taken in Finance Act 2018 to exclude from EIS companies which while having proved popular with some investors are asset-backed and aimed at the preservation of capital rather than being higher risk.
The Finance Act 2018 also includes measures to improve the attractiveness of EIS investment into knowledge-intensive companies, increasing the annual limit for an individual investor from £1m to £2m so long as at least £1m is invested in such a company and the total amount that can be raised by such a company in a 12-month period to £10m.
Now the Government’s latest consultation exercise puts forward proposals for an approved EIS fund model targeted specifically at knowledge-intensive firms. Such EIS funds would have the benefit of aggregating the capital of many investors enabling sustainable and large-scale investment of the kind needed by knowledge-intensive companies while diversifying the risk for any individual investor. EIS funds do already exist but the number targeted at the knowledge-intensive sector remain low.
Additionally, the Government are consulting on the potential further extension of the existing tax reliefs that already apply to EIS investments to make them more generous where they are through an EIS fund. Broadly, the tax reliefs for investment into such a fund might include:
‘Patient’ dividend exemption – an exemption on dividends in respect of shares in knowledge-intensive companies where those shares are held for a fixed period, e.g. 5 years or more. It is also recognised that this may put pressure on companies to pay dividends as opposed to reinvesting their profits to retain and generate investment.
CGT exemption – An exemption for a proportion of other capital gains where invested into a knowledge-intensive EIS fund (similar to the existing SEIS rules).
Extended carry-back facility – Under EIS, the income tax relief afforded to investors may be carried back into the previous tax year where that relief cannot be fully utilised in the year of investment. The Government is considering the ability to carry back income tax relief to earlier periods where the EIS investment is into a knowledge-intensive company
Up-front tax relief – Where EIS investments are made via an EIS fund, the tax relief arises for the investor when the fund makes investments, not when the investor invests into the fund. The Government are considering giving income tax and CGT deferral relief for investment into the fund, with the condition that the capital is invested within a specific time window.
It is welcome that the Government recognises the importance of investment in knowledge-intensive companies and that, while the EIS scheme as it stands is attractive, that there is much more needed to encourage further investment.
Given the additional tax incentives and the focus of the fund model, it is expected that such funds will require HMRC oversight by way of additional reporting requirements and requirements for the fund to invest a significant proportion of its funds into knowledge-intensive companies.
The consultation runs until 11 May 2018.
Both consultations are illustrative of the Government’s interest in promoting entrepreneurship and growth of businesses, especially for knowledge-intensive companies with high growth potential. However, in both instances it is hoped that the measures will not add undue complexity to the existing rules and deter would be entrepreneurs and investors.
Both provide some suggestions as to the future direction of travel in terms of tax policy. If the intention is to more carefully target tax reliefs, might we see other reliefs curtailed or modified? Entrepreneurs’ Relief itself might be one candidate. Just as EIS is being ‘re-set’ to address what was arguably its original aim, promoting investment into high growth companies, might Entrepreneurs’ Relief be re-set to focus on genuinely entrepreneurial activity? And, relatedly, if the intention is to promote longer-term, patient investment, might the 12-month holding period be extended? Let’s see what the Autumn Budget brings.
If you have any queries about anything in this blog or tax matters in general then please do get in touch.