Prior to the 22 November 2017 Budget there were concerns in the industry that the venture capital tax reliefs could be severely curtailed or even withdrawn. The Autumn Budget did indeed introduce changes intended to tighten the rules and preclude ‘low-risk’ investments, but it also improved the position for knowledge-intensive companies by introducing higher investment limits.
In order to prevent SEIS/EIS and VCT tax reliefs being given for investments in low-risk investments, the Government introduced the so-called ‘risk-to-capital’ condition, along with some draft guidance explaining the factors to be considered.
The venture capital schemes are intended to support early-stage, entrepreneurial companies that have potential to grow in the longer term and need financial support to achieve this. The investors are expected to be third parties who are interested in supporting the company and participating in its success but who know their capital is not secured and is at genuine risk of being lost.
The new risk-to-capital condition has two parts which must be met:
(a) the investee company must have objectives to grow and develop over the long term, and
(b) the investment must carry a significant risk that the investor will lose more capital than they gain as a return.
HMRC list certain factors which will be considered to determine whether there is any capital preservation activity, for example:
- looking at whether the turnover or number of employees are expected to increase
- whether the company has any assured income streams in place or assets being used to secure the investment or generate a low-risk income steam
- whether the company has a founder/entrepreneur involved in the business or whether it was set up by a promoter and their associates
- whether the investment is marketed as a short-term investment with low risk, and
- whether large amounts of money are being raised for a number of companies carrying out similar activities.
This will introduce another judgemental element to the relief but the aim of focusing the relief on genuine risk investments is generally welcome. We hope that HMRC will not use these factors in a checklist approach to deny relief for genuine business investments but rather that the risk-to-capital condition, and the factors, will be considered in a balanced way to identify the low-risk investments and capital preservation schemes that the Government are seeking to stop.
Some unexpected positive changes in the Budget relate to ‘knowledge-intensive companies’ (‘KICs’). If the investee company is a KIC it will be able to raise up to £10m in a 12-month period from SEIS, EIS and VCT rather than £5m for other qualifying companies. Additionally, the amount individuals can invest each year in EIS companies has been doubled to £2m per year, provided they invest at least £1m in KICs. The rules around the maximum age of a company to be eligible for EIS and VCT investment are also being relaxed. KICs will be able to elect to measure their age from the point at which their turnover reached £200,000 per year, rather than from their ‘first commercial sale’.
These changes should help boost EIS and VCT investment in innovative, high-tech, research-driven companies and it will now be even more important to identify which companies qualify as KICs. The definition is complex and our new Venture Capital Tax Reliefs book will include a flow chart to assist in identifying whether the conditions are met.
David Brookes, Tax Partner, BDO LLP is the author of the forthcoming Venture Capital Tax Reliefs (3rd edition) (Bloomsbury Professional). For further information, see: https://www.bloomsburyprofessional.com/uk/venture-capital-tax-reliefs-9781526502452/