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Who is likely to be affected
This will affect certain companies and individuals using the Enterprise Investment Scheme (EIS), Seed Enterprise Investment Scheme (SEIS) and Venture Capital Trusts (VCTs), VCTs, fund managers and other promoters and advisers for the EIS, SEIS and VCTs. This measure will not affect independent, entrepreneurial companies seeking to expand.
General description of the measure
The measure introduces a new condition to the EIS, SEIS and VCT rules to exclude tax-motivated investments, where the tax relief provides most of the return for an investor with limited risk to the original investment (that is, preserving an investor’s capital). The condition depends on taking a ‘reasonable’ view as to whether an investment has been structured to provide a low risk return for investors.
The condition has two parts: whether the company has objectives to grow and develop over the long-term (which broadly mirrors an existing test with the schemes); and whether there is a significant risk that there could be a loss of capital to the investor of an amount greater than the net return. The condition requires all relevant factors about the investment to be considered in the round.
The government wants the venture capital schemes to be focused on support for companies with high growth potential. In response to the consultation, ‘Financing Growth in Innovative Firms’, evidence was provided suggesting that a significant subset of EIS investment 2016-17 was focused on capital preservation. The risk to capital condition is a principled approach which enables the government to avoid excluding further specific types of activity, which would risk excluding genuine entrepreneurial businesses, whilst reducing opportunity to use the schemes for tax motivated investment.
Background to the measure
A number of specific trading activities have been excluded from the schemes since 1998 because they offer low risk investment opportunities for investors. Most recently, all energy generation activities were excluded for investments made on or after 6 April 2016.
The government published a consultation, ‘Financing growth in innovative firms’ on 1 August 2017 which asked for views on reducing lower risk capital preservation investments in the venture capital schemes. The government’s response document was published on 22 November 2017.
The new condition will apply to all investments made on or after the date of Royal Assent to Finance Bill 2017-18.
HMRC will cease to provide advance assurances on proposed investments that would appear not to meet the new condition from the date of the publication of draft guidance, which will be alongside the Finance Bill publication process.
The current EIS legislation is contained in Part 5 of the Income Tax Act (ITA) 2007.
The current SEIS legislation is contained in Part 5A ITA 2007.
The current VCT legislation is contained in Part 6 of ITA 2007.
Legislation in Finance Bill 2017-18 will introduce a new qualifying condition (the ‘risk-to-capital condition)’ to Parts 5, 5A and 6 by new sections 157A, 257AAA and 286ZA respectively.
The new condition introduces a principles-based test to determine if, at the time of the investment, a company is a genuine entrepreneurial company. It requires a conclusion to be reached as to whether the company has objectives to grow and develop and whether there is significant risk of loss of capital, where the amount of the loss could be greater than the net return to the investor. All relevant factors must be considered in reaching that conclusion.
The net investment return is defined by reference to the net return to investors including income or capital growth and any income tax relief.
The condition includes a non-exhaustive list of the types of factors that may be taken into consideration when arriving at the conclusion.
These changes are subject to normal state aid rules.
Summary of impacts
Exchequer impact (£m)
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These figures are set out in Table 2.1 of Autumn Budget 2017 as ‘Patient Capital Review: reforms to tax reliefs to support productive investment’ and have been certified by the Office for Budget Responsibility. More details can be found in the policy costings document published alongside Autumn Budget 2017.
The measure is not expected to have any significant macroeconomic impacts.
The costing accounts for behavioural responses to the changes, whereby a proportion of capital preservation investment excluded is reinvested elsewhere through these schemes, and the new incentives to invest in knowledge intensive companies result in increased investment in those.
Impact on individuals, households and families
This measure will affect individuals who subscribe for shares in companies that are carrying out capital preservation activities, often through an EIS fund manager or investment house.
The affected individuals are likely to be affluent but risk-averse because they are not prepared to lose capital on their investments. The numbers of investors affected is not known.
The measure is not expected to impact on family formation, stability or breakdown.
It is anticipated that the changes to the schemes will impact on risk-averse users of the EIS, SEIS and VCT scheme.
HMRC has not identified that any specific groups with protected characteristics that would be affected.
Impact on business including civil society organisations
This measure is expected to impact investment houses, fund managers and other promoters of capital preservation schemes using the EIS, SEIS and VCTs. These businesses may need to find alternative investment opportunities: either higher risk investments within the tax-advantaged venture capital schemes or in the wider market.
Negligible one-off costs include familiarisation with the new rules. Negligible on-going costs may include making arrangements to obtain follow-on funding.
Operational impact (£m) HM Revenue and Customs (HMRC) or other
The costs to HMRC of implementing these changes are anticipated to be negligible. Some resource may be freed up as the changes should result in fewer applications at the advance assurance stage.
Justice impact test: there may be more appeals against HMRC decisions to refuse to authorise companies to issue compliance certificates to their investors, as the new law is tested. A justice impact test will be completed.
Other impacts have been considered and none have been identified.
Monitoring and evaluation
The measure will be monitored through applications from companies to HMRC under the schemes, and by the amount of funds raised by companies using the EIS, SEIS and VCTs.