In his Spring Statement Chancellor Philip Hammond announced plans to unlock £20bn of investment in innovative firms over ten years, with the introduction of a new approved fund structure within the Enterprise Investment Scheme (EIS), with the possibility of additional incentives to attract investment
Such a fund structure would be focused on mainly investing in knowledge-intensive companies, and was outlined in Autumn Budget 2017 as part of government initiatives to encourage more availability of ‘patient’ capital. The government is now consulting on its proposals and seeks views on possible elements and constraints of such a fund structure, while also seeking to better understand the capital requirements of innovative knowledge-intensive companies.
This consultation aims to build the government’s understanding of the capital gap that knowledge-intensive companies face, and seeks views on the best way of closing that gap. It explores possible options for an EIS fund structure aimed specifically at investment in knowledge-intensive companies, while making clear the limitations within which such a fund model would operate.
The government considers that the definition of a knowledge-intensive company that is currently used in the venture capital schemes effectively captures the types of firm that have the most acute problems gaining investment. It is also conscious of the need for both investors and companies to have as much stability as is possible. It therefore intends to base any new fund structure on this existing definition.
The EIS is a notified state aid and any changes to the scheme will have to take into account constraints on state aid. This consultation may lead to changes before the UK leaves the EU. As the UK is still subject to state aid rules the consultation seeks responses consistent with the current state aid regime.
The design of any fund model would need to be proportionate to an identified market failure in the supply of capital to knowledge-intensive firms. The government is not considering raising the rates of income tax relief for the schemes.
Any design would also need to ensure value for money for the taxpayer and to balance the government’s need to ensure fairness across the tax system. It should be robust enough to defend against attempts to use the fund model for aggressive tax planning or capital preservation purposes.
The consultation makes clear the government does not intend to introduce a new scheme, and envisages any new fund model as building on the existing EIS rules. It does not, for example, plan to change the requirement that all EIS investment must be equity investment in ordinary shares, or to reduce the three-year holding period that applies to EIS investments.
Any new fund model would need to focus on investing nearly entirely in knowledge-intensive companies. However it is possible that a small proportion of investments, possibly 10%-20%, could be in non-knowledge intensive EIS companies.
The government anticipates that any new knowledge-intensive fund would be subject to HMRC approval. This would place a compliance obligation on fund managers, although the precise extent of this would depend on the incentives attaching to the fund and the way in which tax relief is given.
The consultation asks for views on a range of alternative incentives. A ‘patient’ dividend tax exemption could be applied in respect of investments made through a knowledge-intensive fund. Investors would not pay tax on dividends received from knowledge-intensive investee companies after a fixed holding period (say five or seven years).
The EIS currently allows investors to defer CGT on gains to the extent that the disposal proceeds are reinvested in EIS qualifying companies. An alternative approach could be taken under which investors are allowed to write off a proportion of a capital gain on reinvestment into a knowledge-intensive fund.
The EIS rules allow investors to set their income tax credit against tax liabilities of the year of investment, or the prior year. This could be widened to permit a further carry-back for investors in a knowledge-intensive fund. This could be an alternative to providing income tax relief at the time of contributing capital to the fund, which the consultation argues would be highly complex and involve significant additional burdens for fund managers.
The consultation acknowledges that these options would add greater complexity to the EIS rules than other options. It would be necessary to regulate how capital awaiting investment is dealt with, for example in bonds or cash. It would also be necessary to introduce new compliance processes to withdraw relief if the fund ceases to be eligible. The time such legislation would take to develop and implement would be longer than other options. There would be additional administrative obligations, and constraints on what can be done with yet to be invested funds would be placed upon fund managers.
The consultation makes clear the government will not provide all of these additional incentives, and the final model will focus on the most important elements for helping to address the knowledge-intensive patient capital funding gap.
The consultation closes on 11 May.
Report by Pat Sweet