Reform of venture capital and creation of seed enterprise investment relief: draft Finance Bill 2012

Practical Law UK Legal Update 1-515-4548 (Approx. 7 pages)

Reform of venture capital and creation of seed enterprise investment relief: draft Finance Bill 2012

by PLC Tax

Background

In the 2011 Budget, the Chancellor announced the following changes to the enterprise investment scheme (EIS) and the venture capital trust (VCT) scheme, to be implemented in the Finance Act 2012 and to take effect from, broadly, 6 April 2012:

An increase in the EIS annual investment limit for investors from £500,000 to £1 million.
Increases in the investee company's gross assets, employee and annual investment limits, specifically:
- an increase in the gross assets test from £7 million immediately before the share issue and £8 million immediately after to £15 million immediately before investment;
- an increase in the employee limit from 50 employees to 250 employees; and
- an increase in the annual amount that can be invested in an individual company from £2 million to £10 million.

In addition, the government promised to consult on further changes to the schemes, including consulting on proposals to give support to companies through EIS for seed investment.

On 6 July 2011, HM Treasury published a consultation paper outlining the government's proposals for refocusing and simplifying the venture capital schemes and creating a new scheme for seed investment. In particular, the consultation paper confirmed that the government would amend the existing EIS rules to:

Permit investment in shares that carry certain preferential rights to dividends.
Remove the loan capital element of the capital connection test.

In addition, the consultation paper confirmed that the government intended to introduce legislation to prevent EIS and VCT reliefs being available to:

Companies set up solely to allow tax reliefs to be accessed.
Companies (other than certain excluded community-type companies) whose trades consist wholly, or to a substantial extent, of the receipt of feed-in tariffs.
Companies that are preparing to trade if this involves the company raising funds to acquire a trading company. In the consultation paper, this restriction applied only if the group post-acquisition failed the size conditions (gross assets and employees test).

The consultation paper also sought views on potential future simplification ideas. These included:

The extent to which the anti-protection provisions in the EIS rules deterred investment.
Whether loss of EIS relief on a merger caused issues in practice.
Whether there should be a period of grace for the payment of shares.
Whether the current list of excluded activities should be reviewed.

The government also set out its proposals for a new tax-advantaged venture capital scheme for start-up businesses.

For further details about the consultation paper, see Legal update, Reform of venture capital schemes and creation of seed investment scheme: consultation.

The reform, simplification and new venture capital scheme measures were confirmed in the Chancellor's Autumn Statement: see Legal update, 2011 Autumn Statement: business tax implications: Seed Enterprise Investment Scheme and venture capital reform. In addition, the government confirmed that it had decided to remove the restriction in the VCT rules that a VCT can only invest up to £1 million in a qualifying company.

Development

Venture capital reform and simplification

Draft legislation (accompanied by draft explanatory notes and tax information and impact notes) to implement the venture capital reform and simplification proposals (see Background) was published on 6 December 2011. The closing date for submitting comments on the draft legislation is 10 February 2012. HMRC also published a response document to the summer consultation.

The draft legislation generally reflects the reform and simplification proposals (see Background) except that:

The draft legislation treats the acquisition of shares in another company as a non-qualifying activity unless the acquisition is a subscription for shares in a new 90% qualifying subsidiary. This is a departure from the proposal outlined in the summer consultation document (which was for the acquisition to qualify provided that post-acquisition, the group continued to meet the EIS and VCT size conditions).
The approach to excluding companies established for the purpose of accessing reliefs is different to that proposed in the summer consultation document (although the government considers that the principle and effect of the draft legislation remains the same).
The removal of the VCT maximum investment rule will not apply if the investee company is a member of a partnership or joint venture. The maximum investment limit in these cases will be £1 million divided by the number of partners or participants in the joint venture.

It is confirmed in the response document that the government does not intend to take any immediate action to take forward the future potential simplification ideas, including the period of grace idea (see Background). However, HMRC has revised its guidance to make the requirement that shares must be fully paid up clearer.

To track the progress of this measure to implementation, see Tax legislation tracker: owner-managed business: Venture capital schemes and enterprise investment scheme: various amendments.

Seed enterprise investment scheme relief

The draft legislation to implement the new tax-advantaged venture capital scheme announced as part of the 2011 Budget and confirmed in the Chancellor's Autumn Statement (as to which, see Legal update, 2011 Autumn Statement: business tax implications: Seed Enterprise Investment Scheme) was published on 6 December 2011. The closing date for comments is 10 February 2012.

Also on 6 December 2011, HMRC published a technical note on the capital gains tax exemption for gains realised on disposals of assets by individuals in 2012-13 and invested through SEIS in that year. Draft legislation to implement the CGT exemption will be published in January 2012.

Income tax relief

The draft legislation reflects the previously announced detail that the scheme (re-named the Seed Enterprise Investment Scheme) (SEIS) will be available from 6 April 2012 and will provide income tax relief of 50% for individuals who invest in shares in new qualifying companies (whose total assets must be below £200,000), with an annual investment limit of £100,000. The maximum amount that a company can receive under SEIS is £150,000.

As expected, the draft legislation is heavily based on the EIS rules (as to which, see Practice note, Enterprise Investment Scheme (EIS)) but there are some significant differences, including:

Employees of the issuing company and their associates will not qualify for SEIS relief unless the relevant employee is also a director of the issuing company. In contrast to EIS relief, there is no requirement for directors to be unpaid directors at the time they acquire SEIS shares or to satisfy any “business angel” conditions. There would appear to be nothing to prevent the shares falling within the employment-related securities regime (as to which, see PLC Share Schemes & Incentives, Practice note, Employment-related securities), giving rise to the potential for income tax and National Insurance contribution charges and employer reporting obligations.
There is no minimum investment amount.
Interest relief for money borrowed to invest in the qualifying company under section 392 of the Income Tax Act 2007 is not excluded.
The issuing company:
- must not be a member of a partnership;
- must be no more than two years old when the SEIS shares are issued;
- must not have gross assets in excess of £200,000 and must have fewer than 25 full time employees (or their part-time equivalent). (For the purpose of these tests, an appropriate proportion of any related entity's gross assets and employees must be included. A related entity is one that holds 25% or more of the capital or voting rights of the issuing company);
- must not have raised any money through the EIS or VCT schemes; and
- must, within three years, spend all the money raised by the share issue (other than insignificant amounts) on qualifying business activities (the definition of "qualifying business activities" broadly reflects the EIS definition except that the qualifying trade must also be a "genuine new venture" and the acquisition of shares in a company is not a qualifying business activity);
- must carry on the qualifying business activity itself rather than through a 90% subsidiary.
There is no withdrawal or reduction of SEIS relief on the repayment of share capital to persons unconnected with the investor.
Claims for SEIS income tax relief may only be made once 70% of the money raised by the issuing company has been spent on qualifying business activities. The issuing company must not issue a compliance certificate until that time.
There is no continuity of SEIS relief if the issuing company is acquired by another company by way of a share-for-share exchange.

In line with the amendments to the EIS rules, SEIS investors will be able to subscribe for shares that carry certain preferential rights to dividends and the connection test ignores loan capital.

From 6 April 2013, it will be possible for investors to carry back investments made in one tax year to the previous tax year. This means that an investor may invest £150,000 in one company in 2013-14 and elect to carry back £50,000 of that investment to 2012-13 and claim full tax relief.

A consequential amendment is made to the EIS and VCT scheme rules to ensure that if funds are raised under SEIS, no funds can be raised under EIS and VCT until 75% of the SEIS funds have been spent.

Capital gains tax exemption on disposal of SEIS shares

A consequential amendment is made to the capital gains tax rules to mirror the EIS disposal exemption (as to which, see Practice note, Enterprise Investment Scheme (EIS): Capital gains tax exemption and loss relief).

Capital gains tax exemption for gains invested in SEIS in 2012-13

As mentioned above, draft legislation to implement the CGT exemption will be published in January 2012 for consultation. The technical note confirms that for the CGT exemption to apply, the investment must qualify for income tax relief throughout the three-year qualifying period. It will be possible to claim partial exemption if only part of the gain arising on the disposal is invested in SEIS shares. If income tax relief is withdrawn, CGT exemption will also be withdrawn and the previously exempt amount will be liable to CGT.

To follow progress to implementation, see Tax legislation tracker: owner-managed business: Venture capital schemes and enterprise investment scheme: reform and new seed investment scheme.

Comment

As most of the reform and simplification measures and the principles of SEIS relief have been widely consulted on, the measures and the draft legislation will be broadly welcomed. However, there are some issues that need to be resolved or that might cause concern. In particular:

The potential for SEIS investors to be caught by the employment-related securities rules.
The lack of continuity of SEIS relief on an acquisition of the issuing company on a share-for-share exchange.
The government's change of approach on the use of EIS monies to acquire a subsidiary by buying shares from existing shareholders (although the government's approach will be dictated by the EU state aid rules).

HMRC has not confirmed whether an advance assurance process will be available for SEIS relief.

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