EIS, SEIS and VCT reliefs: risk to capital

Part of Finance (No. 2) Bill – in a Public Bill Committee am 2:30 pm ar 9 Ionawr 2018.

Danfonwch hysbysiad imi am ddadleuon fel hyn

Photo of Mel Stride Mel Stride Financial Secretary to the Treasury and Paymaster General 2:30, 9 Ionawr 2018

Clauses 14 to 17 and schedules 4 and 5 make changes to the tax-advantaged venture capital schemes as part of the Government’s response to the patient capital review. They also correct minor technical flaws in the legislation, to ensure that the legislation works as intended. The changes aim to drive more than £7 billion in new and redirected investment into high-growth companies over the next 10 years.

Responses to the patient capital review consultation pointed to the continuing importance of these schemes in incentivising investment in early-stage companies that would otherwise struggle to receive investment to help them grow and develop. However, evidence provided during the consultation, backed up by Sir Damon Buffini’s industry panel, suggested that knowledge-intensive companies, which are particularly research and development-intensive, still struggle with some of the most acute funding gaps, despite their growth potential. This is because they often require a large amount of capital up front to fund their growth, and it can be many years before their products can be brought to market. Evidence provided through the consultation also highlighted a large subset of low-risk capital preservation investments structured around the tax reliefs. One response showed that £467 million of funds raised by enterprise investment scheme funds in 2016-17 were aimed at schemes that could be described as capital preservation.

Clause 14 introduces a new “risk to capital” condition for the enterprise investment scheme, the seed enterprise investment scheme and venture capital trusts, in response to evidence of continuing capital preservation investments using the venture capital schemes. The condition takes a principles-based approach to deny tax relief to these investments. Investments will be excluded where it is reasonable to conclude that the company does not have the objective of growing and developing its trade in the long term and there is no significant risk that any loss of capital will be greater than the net return on the investment. The measure would take effect from Royal Assent.

Clause 15 makes technical changes to ensure that the rules on determining the amount of funding a company may receive in its lifetime, under the EIS, VCTs or social investment tax relief, work as intended. The clause ends certain transitional provisions introduced in 2007 and 2012, which excluded certain investments from counting towards the lifetime limit, and ensures all risk finance investments are counted towards the lifetime funding limits for the EIS, VCT and SITR schemes. This will apply to new investments on or after 1 December 2017.

Clause 16 and schedule 4 make three changes in response to the patient capital review. The changes will significantly expand the support offered to knowledge-intensive companies through the EIS and VCTs. The annual limit on how much an investor can invest through the enterprise investment scheme will be raised from £1 million to £2 million. Any investment over £1 million must be invested in knowledge-intensive companies.

Knowledge-intensive companies often need large funding rounds as they are highly capital-intensive. With this in mind, we are doubling the annual investment limit for knowledge-intensive companies using the EIS and VCT schemes to £10 million. Under the current EIS and VCT rules, knowledge-intensive companies must be broadly under 10 years of age when receiving their first qualifying investment. The clock starts when the company makes its first commercial sale. Knowledge-intensive companies sometimes find this point difficult to identify. Clause 16 introduces flexibility to this rule by allowing knowledge-intensive companies to choose to start the clock at the point they reach an annual turnover of £200,000.

Before I turn to Government amendment 1 to schedule 5, I will give some background, if I may, to introduce clause 17 and the schedule. Clause 17 and schedule 5 make changes to the VCT rules. Schedule 5 corrects a technical flaw and changes some of the rules to encourage VCTs to invest more of their funds in qualifying growth companies and to invest those funds more quickly. Government amendment 1 introduces new rules on qualifying loans to encourage VCTs to make longer-term investments in higher-risk companies. Some VCTs have used loan structures as a method of capital preservation, charging prohibitively high interest rates and including other conditions in the terms of the loan. The effect is to secure a return of capital well before the end of the five-year minimum period. Amendment 1 is intended to prevent the use of low-risk loans to minimise risk to the VCT and to its investors, including where the terms involve very high interest rates, redemption premiums and other charges. I commend Government amendment 1 to the Committee.

I turn to the rest of the provisions in schedule 5. The schedule corrects a flaw in an anti-abuse rule introduced in 2014 to prevent investors from being punished for mergers they did not know were about to occur. The changes will apply retrospectively, from the introduction of the anti-abuse rules in April 2014. The proportion of VCT funds that must be invested in qualifying companies will be raised from 70% to 80%. This will ensure that a greater proportion of VCT funds reaches the target companies. Once a VCT realises a gain by disposing of an investment, it must reinvest that gain within six months. Many VCTs currently pay out the proceeds as a dividend instead. To encourage more reinvestment by VCTs, schedule 5 raises the reinvestment period to 12 months. These last two changes take effect from April 2019 to allow VCTs time to adjust their investment portfolio.

VCTs currently have up to three years to invest funds after those funds are raised. A new rule will require them to invest at least 30% of funds in qualifying companies within one year of the end of the accounting period in which they were raised. This will accelerate investment of money raised from investors and will apply to funds raised from 6 April 2018.

Many previous changes to the VCT rules have been grandfathered. This means new investments can still be made under the old rules that applied when the money was originally raised. These transitional provisions enable some VCTs and their investors to access a range of generous tax reliefs on low-risk investments. The schedule will ensure that all VCT investments meet the current rules, regardless of when the original money was secured. These changes will take effect for investments from 6 April 2018.

New clauses 6 to 8 call for reviews into some of the changes made in this legislation, as well as a review of the efficacy of the venture capital schemes as a whole, but the changes made in the legislation are the result of a thorough review of all the venture capital schemes as part of the patient capital review. The review concluded that the schemes did vital work in providing capital for high-growth companies but that certain changes would make the schemes more effective and fairer for the taxpayer. Because we are committed to making the schemes work better, the Government have already committed to a report on the changes. An initial report to the Chancellor of the Exchequer for Budget 2018 will set out how the different measures in the Government response are being implemented. Then, in autumn 2020, a report will assess the impact of the policies set out in the Government response, including the clauses in this Finance Bill.

A review of this condition any earlier than 2020 would not be able to make any reasonable assessment of the effect of the changes on the scheme. It would be working from a single year’s data on the impact on Government revenue and would be unable to assess the impact on the long-term growth and development of businesses. In the meantime, HMRC publishes statistics on the use of venture capital schemes every year. The information includes details of amounts invested and company activities. The first figures reflecting the effect of the new changes for the tax year 2018-19 will be available in April 2020. These will be closely monitored. I therefore urge the Committee to reject the new clauses.

Sir Roger, these changes significantly expand the venture capital scheme’s innovative, knowledge-intensive companies while reducing the scope for low-risk investment within them. They will drive more than £7 billion of investment towards high-growth companies over the next 10 years and ensure the smooth operation of these important schemes. I therefore commend clauses 14 to 17 and schedules 4 and 5 to the Committee.