Important news on tax-advantaged venture capital schemes

The Government issued a consultation paper last month proposing big tax changes to the UK’s venture capital scheme landscape.

In a Nutshell

• A brand new tax relief, called “BASIS”, is proposed, to encourage business angel investment for start-up businesses.
• The existing Enterprise Investment Scheme (EIS) and Venture Capital Trust (VCT) schemes will be extended and simplified.

A New BASIS

The Government has recognised that start-ups can find it difficult to attract meaningful levels of funding.

A new tax relief scheme is proposed, separate from the existing EIS and VCT schemes, for business angels to invest capital and expertise in start-ups. It will be called the Business Angel Seed Investment Scheme (BASIS).  Details are light at this initial stage, but it is likely that BASIS will offer more generous tax relief than EIS and VCT schemes.

Criteria
 
The investment is intended for only seed stage businesses. Whilst no formal definition has been agreed, suggestions include a company that has not yet begun to receive income from trade; has gross assets of less than a set amount; is involved in developing a prototype, or perhaps a company that is not yet engaged in large scale commercial manufacturing.

Qualifying investors in BASIS will need to be “business angels”. This might be an individual that can show relevant experience (e.g. previously invested in four or more seed stage companies) and that will play an active role in the governance of the investee company, perhaps as an executive director. In other words, some active involvement in the business will be necessary. The Government is consulting on permitting syndicates of qualifying investors, although there may be limits on their single or aggregate stake in the company.

It is possible that qualifying investment will not be limited to ordinary equity, and that it will include quasi-equity and loan capital (although probably no more than 30% loan capital). This is a potentially significant and welcome departure from the current EIS and VCT requirements.

Will BASIS have a big impact?

In short, yes, particularly for start-ups, where being able to offer a higher rate of tax relief over EIS and VCT investment might make a crucial difference.

As always, the devil will be in the detail, particularly as to qualifying companies and what precisely a “business angel” will be (and how many investors will in practice fall within the definition).

Where does that leave EIS and VCT?

Budget 2011 proposed long overdue reforms to both of these tax relief schemes, including raising the rate of EIS income tax relief from 20% to 30%. This change came into force in April this year.

Subject to State Aid approval, the Consultation reiterates welcome and important extensions to EIS and VCT reliefs:

• increasing the annual funding limits for EIS and VCT investee companies from £2m to £10m;
• increasing the qualifying EIS and VCT investee company limits from not more than £7m gross assets to not more than £15m, and from not more than 50 employees to not more than 250; and
• increasing the cap on an investor’s annual EIS investments from £500,000 to £1m.

If approved, these changes will take effect in April 2012.

In addition, the Consultation proposes a “simplification” process, with smaller changes, including:

• aligning the definition of a qualifying share under both the EIS and VCTs to assist companies which receive investment, widening eligible shares to include, subject to certain restrictions, shares with preferential rights to income and assets;
• changes which might allow certain anti-dilution arrangements; and
• relaxing the rules around qualifying investors to allow emergency funding from existing investors.

It is not all good news

The Consultation is broadly positive, but the Government is taking the opportunity to ensure the focus of the tax reliefs meets its policy aim. EIS and VCT structures have been used by some investors to maximise tax relief, but in ways aimed at minimising the risk to capital. The schemes were meant to encourage capital investment in riskier enterprises. The Government has proposed a test to ensure that this is the case with a view to preventing the perceived abuses of the schemes.

The paper reaffirms provisions announced in Budget 2011 about the exclusion of trade receipts from the feed-in-tariffs scheme under EIS and VCTs, except in limited cases, broadly with effect from April 2012.

It also promises a review of the excluded activities test, which may prevent the use of EIS and VCT tax relief schemes in certain sectors.

Responding to the Consultation

The Consultation gives a forum for investors, investees and advisers to help shape the new relief and the changes to the existing reliefs. The Consultation closes on 28 September 2011. Field Fisher Waterhouse will be working with clients and responding formally to the Consultation. If you would like more information or to join in our response and contribute your views, please contact Andrew Prowse, Mark Gearing or Derek Hill.