HomeInsightsStreamlining the tax-advantaged venture capital schemes

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This article was first published by LexisNexis PSL in January 2017.

Tax analysis: Sue Crawford, partner, and Andrew Lindsay, associate at Wiggin LLP, examine the proposals in the draft Finance Bill 2017 and the consultation paper on advance assurance concerning the Seed Enterprise Investment Scheme (SEIS), Enterprise Investment Scheme (EIS) and venture capital trust (VCT) schemes, assessing their potential impact and what they mean in practice.

Original news

Consultation on streamlining advance assurance for venture capital schemes, LNB News 08/12/2016 118

HMRC is consulting until 1 February 2017 on five options for streamlining the advance assurance service for companies using the tax advantaged venture capital schemes, as HMRC’s resources struggle to meet demand.

Government publishes draft Finance Bill 2017 legislation, LNB News 05/12/2016 73

The government published draft tax legislation on 5 December 2016 for inclusion in Finance Bill 2017. Consultation on the draft legislation will run until 1 February 2017.

What are the proposals relating to share conversion rights for EIS and SEIS investments in draft clause 15 of Finance Bill 2017 and what do they mean in practice?

Under both EIS and SEIS legislation (sections 177(1) and 257CD(1) of the Income Tax Act 2007 respectively) there is a prohibition on having pre-arranged exit mechanisms in place. As EIS and SEIS are designed to promote investment into riskier companies with significant tax breaks, investors should not be able to guarantee an exit and de-risk their investment.

Previously though, HMRC has taken a too broad approach in determining what these ‘arrangements’ cover, and viewed shares which had the right to convert into another class as a disposal (which is prohibited during the EIS/SEIS qualifying period if tax reliefs are to be maintained). Common mechanics, such as the conversion of shares into a single class to facilitate a listing or to deferred shares in leaver scenarios, fell foul of this—resulting in companies not being eligible for relief.

Practically this new exemption will allow companies to receive assurance with more appropriate future-proofed constitutional documents. However, it should be noted that it is only the right to convert which is exempt—the conversion itself (if within the qualifying period) will still potentially remove relief depending on how it is structured.

What does draft clause 16 of Finance Bill 2017 propose in relation to follow-on funding for investments made by VCTs following a reorganisation?

Currently, the EIS rules already allow a new parent company that has acquired an EIS company via a share for share exchange to receive follow-on funding in certain instances.

Clause 16 will bring the VCT rules in line with those of EIS. As noted above the disposal of shares is prohibited during the qualifying period (if tax reliefs are to be maintained). The draft clause is designed to give VCT companies greater flexibility to restructure, and allow new parent companies, who have acquired a company via an approved share for share exchange, to receive VCT funding based on the subsidiary’s funding history.

It should be noted though that there will be a number of restrictions in place for the follow-on funding—the finance will only be able to be used for the activities of the subsidiary prior to the reorganisation, and permitted age requirements will also apply.

Why are these provisions deferred until April 2017 given the EIS and SEIS changes have come in from 5 December 2016?

There has been very little recent government comment on these follow-on funding rules. The changes stem from technical discussions with advisers and VCTs following the new general age limit introduced by Finance (No 2) Act 2015—the agelimit rule of seven years was subject to an exception that allowed follow-on funding. Clause 16 gives VCTs which have reorganised through share for share exchanges to take follow-on funding where previously this was prohibited.

Do any of the proposed options for stream-lining the advance assurance process ring alarm bells for the industry or advisers?

With the advance assurance process now initially taking between six to eight weeks (not including follow-up queries and/or correspondence), streamlining the process is needed to help both investee companies and investors.

A number of the proposed options are promising, such as allowing a service for technical aspects of the rules (where advisors/companies normally have the most concern) which would hopefully allow more clarity and certainty in a shorter timeframe. Likewise, the possibility of HMRC pre-agreeing standard documents (eg articles of association) for EIS companies from the same stable/sponsor is being mooted which would help standardise the process.

However, one of the options, withdrawing the advance assurance service entirely, is worrying. Many investors require a company to have received advance assurance before they invest. Removing the process would likely lead to investors limiting their investment in SEIS and EIS companies. Additionally, with HMRC’s interpretation and application of the legislation changing over time, it is impossible for advisors to be able to guarantee a company being eligible for relief.

A number of the proposals would result in more investigation by HMRC at the compliance statement phase, do you see problems with that aspect of the proposals?

Increased investigation and workloads for HMRC personnel at the compliance statement phase, driven by a more limited advance assurance process to cut delays there, could simply lead to increased time frames to receive confirmation at this later stage. The practical risks of companies retrospectively failing to qualify for SEIS/EIS relief also needs careful thought.

Is there any news on the promise of a digital process for EIS and SEIS compliance?

HMRC is planning to both digitise the advance assurance application and submitting the compliance statements. While we expect Form SEIS/EIS 1 and certifications to be easily digitised, we expect HMRC’s priority is to determine the optimum process for advance assurance and this may take some time.

Is the decision not to introduce rules allowing replacement capital a disappointment to the industry?

Yes. Allowing replacement capital (the purchase of shares from existing shareholders as part of the process of taking in new, generally significant, investment into a business) would have given more flexibility to the scheme, and allow companies the ability to scale up. The Treasury has stated that it will look at the issue of replacement capital over the longer term. Hopefully, we as an industry will be able to address any concerns it has to allow successful growing companies more finance opportunities.

Interviewed by Susan Ghaiwal.