Over the last year the UK Government has been exploring ways to alter the rules for venture capital schemes. The aim is to encourage investment into knowledge-intensive companies and to encourage investment over a longer period.
The initiatives include the Seed Enterprise Investment Schemes (SEIS), the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCTs). The idea here is that many such businesses, while having a high growth potential, are R&D and capital intensive and have great difficulty in obtaining the capital they need.
The UK Government has now said that it will consult on a new EIS fund structure aimed at improving the supply of capital to such companies. The consultation was launched as part of the recent Spring Statement.
There are though some definitions of ‘knowledge-intensive’ that need to be met to qualify for the more generous reliefs and these are in two parts:
The company either or both:
- Must have spent at 15 percent of operating costs on R&D or innovation in one of the three years preceding investment;
- Must have spent at least 10 percent of operating costs on R&D or innovation in each of the preceding three years.
The company must also meet either the innovation or skilled employees condition:
- The company must be creating or have recently created intellectual property which can be used in the future to maintain its business activities. There are requirements to show how meeting this condition can be proven; or
- At the time of investment and for the following three years at least 20 percent of the company’s full-time equivalent employees must be skilled, with a relevant Masters’ or higher degree carrying on R&D or innovation activities.
The UK Government has set out its views on how such a fund could be better tailored to investors. It will be based on existing EIS rules, but the tax incentives available would be improved to make the fund more attractive. The rate of income tax relief on the amount invested will be maintained at the current level of 30 percent.
However, unlike the existing rules for EIS funds where tax relief is only given when the funds are invested in qualifying companies, the new fund will allow tax relief at the point at which the fund is closed. This will be subject to a requirement for the fund to invest at least 90 percent of the funds within 12-months of the fund closing. As an alternative, the UK Government is suggesting that the period for carry-back of the EIS relief, which is currently to the previous tax year, could be extended back even further.
To better promote patient capital, a dividend exemption is suggested which will apply to investments made through this new type of fund. The exemption will only apply to dividends received from knowledge-intensive companies after a fixed holding period of say five or seven years. If such a company becomes profitable then this exemption could be very valuable to investors.
It is also proposed that where an entrepreneur reinvests a capital gain into the new fund then part of that gain will be written-off for tax purposes and will not be taxed. This concession will be similar to the existing relief for SEIS where 50 percent of reinvested gains can be written-off.
It should be emphasised that the consultation document makes it clear that not all of the incentives will be granted in the event. However, the proposals are interesting. In particular, the dividend exemption is an incentive for business angels to leave their capital in the company for the long term.
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