New risk to capital condition
The Finance Bill 2017-18 includes a proposal to introduce a new ‘risk to capital’ condition for companies raising capital under the Enterprise Investment Scheme (EIS), Seed Enterprise Investment Scheme (SEIS) and Venture Capital Trust (VCT) rules, with the aim of disqualifying companies where there is low risk to the investors’ capital.
This measure is intended to focus the schemes towards companies seeking investment for long term growth and development. Tax motivated investments, where tax relief provides all or most of the return for an investor, with little or no risk to capital, will be disqualified.
The new provisions will take effect from the date of Royal Assent to the Finance Bill, but HMRC will not issue advance assurances in response to applications from companies:
- From 4 December 2017, where the application appears to fail the new risk to capital condition
- From 2 January 2018, where HMRC considers the application to be ‘speculative’.
The risk to capital condition will be met if, having regard to all the circumstances existing at the time of the issue of the shares, it would be ‘reasonable to conclude’ that the company has long term objectives to grow and develop, and there is a significant risk that there will be a loss of capital of an amount greater than the net investment return. Here, ‘Loss of capital’ means loss of some or all of the amounts subscribed by the investors, and ‘net investment return’ is the return to investors (including income or capital growth) taking into account the EIS/SEIS/VCT relief.
There are seven “circumstances to which regard may be had”:
- The extent to which the company’s objectives include increasing the number of its employees or the turnover of its trade.
- The nature of the company’s sources of income, including the extent to which there is significant risk of the company not receiving some or all of the income.
- The extent to which the company is likely to have assets, or is or could become party to arrangements for acquiring assets, that could be used to secure financing from other persons.
- The extent to which the activities of the company are subcontracted to persons who are not connected with it.
- The nature of the company’s ownership structure or management structure, including the extent to which others participate in or devise the structure.
- How any opportunity for investment in the company is marketed.
- The extent to which arrangements are in place under which opportunities for investments in the company are marketed or may be marketed with, or otherwise associated with, opportunities for investments in other companies or entities.
HMRC states that the existence of one or more of these ‘circumstances’ will not necessarily disqualify the proposed EIS qualification and that an overall judgement will be made, but the absence of any of the above factors would not necessarily mean that a company would meet the test.
The key will be to demonstrate that the company is a genuine entrepreneurial business and not a “scheme”.
On the positive side, from 6 April 2018 knowledge-intensive companies (KICs) will be able to raise more capital under the EIS and VCT rules – the annual limit will be doubled to £10m per year. The rules around the maximum age of a company to be eligible for EIS and VCT investment will also be relaxed – KICs will be able to elect to measure their age from the point at which their turnover reached £200,000 per year, rather than from their ‘first commercial sale’.
Additionally, the amount individuals can invest each year in EIS companies will be doubled to £2m per year, provided they invest in at least one KIC. These changes will be subject to EU State Aid approval.
For help and advice on any venture capital scheme issues please contact Mark Ward.