EIS Industry Report 2019/20

14 15 IMPACT OF RULE CHANGES EIS IS STANDING UP WELL TO THE CHANGES EIS AND THE NEW THRESHOLDS – A RECAP The ‘principles-based’ test: • Schemes must be focused on companies seeking investment for their long-term growth and development • Will not affect independent, entrepreneurial companies seeking to expand The ‘risk to capital’ condition: • HMRC will take a ‘reasonable’ view as to whether an investment has been structured to provide a low risk return for investors • Has two parts: whether the company has objectives to grow and develop over the long term; and whether there is a significant risk that there could be a loss of capital to the investor of an amount greater than the net return Greater detail on the new rules can be found in our 4th edition of this report, the EIS Industry Report 2018 As a result of the new rules focusing on growth, it is widely assumed that inflows into EIS funds will see a substantial drop in the 2018-19 figures when they are published in 2020. However, this is not necessarily a cause for gloom. Brownridge, for example, expects a drop of around £350 million - and he doesn’t see that lasting. “With education and information for advisers, it will hopefully be a blip,” he told us in August 2019. “A lot of advisers have been weaned on capital-backed EIS, so we and the wider industry need to go on that education journey with advisers.” A £350 million reduction was described as “a very positive sign” by Daniel Rodwell, chief executive of GrowthInvest. Speaking to Investment Week in July 2019, he explained that historically, investment into low-risk capital preservation strategies amounted to around £850 million in the years prior to the government’s Patient Capital Review, so “it would be fair to deduce that around £500 million of EIS investment has already made the transition from capital preservation to growth investments” 3 . This optimistic outlook is shared by others. Neil Pearson, partner at law firm Mills & Reeve, referred to the previous time changes were made to the scheme: “History tells us that when the rules are tightened, as they were in 2015, it had no impact on investor sentiment, mainly because the incentives [for using EIS] are so strong.” One area where the rules had initially been expected to have a big impact was in the media and entertainment sector. As most investments in this sector had been in project-based companies, the changes requiring EIS money to be focused on long-term growth seemed to suggest the end of EIS investments in this sector. Plus, money now needs to be genuinely ‘at risk’, so that the traditional use of pre-sales by film and media bodies looked to have taken the sector outside the rules. However, as we shall see in the sector analysis section, as one old media star may have put it, those initial reports of media & entertainment’s death in the EIS market appear to have been an exaggeration. Considering the case law Since the introduction of the new growth capital requirements, one area of difficulty for the market has been the lack of clarity as to whether HMRC’s guidance can be relied on by taxpayers, and in what circumstances the courts will uphold a decision by HMRC which departs from its own guidance. One positive development in this area was the decision of the Upper Tier Tribunal in the Ames cases ([2018] UKUT 190 TCC). HMRC had claimed that CGT exemption on a disposal of qualifying shares was only available where EIS income tax relief had also been claimed. However, the taxpayer argued that this was not clear from the HMRC guidance in leaflet IR 137, and that he had also been told by a responsible HMRC official that he would qualify for CGT exemption, and could rely on the leaflet to support this, even though he had not claimed EIS income tax relief. By the time HMRC sought to argue that in fact CGT exemption was not available, he was clearly out of time, under normal circumstances, to make a claim to income tax relief, and HMRC refused to exercise its discretion to allow a late claim. The Tribunal was clearly somewhat nervous about making a full finding that HMRC’s decision was unreasonable in the administrative law sense, but was content to quash it and require HMRC to reconsider the position. It noted that “even an expert and conscientious tax adviser retained by HMRC misunderstood HMRC’s guidance as it applied to Mr Ames’ circumstances”. “It should not take an Upper Tier Tribunal appeal, where a taxpayer is risking costs as well as the tax at stake, to reach this point,” says Sarah Lane, partner in Burges Salmon’s corporate tax team. A more recent decision, from the Court of Appeal in the Aozora GMAC case ([2019] EWCA Civ 1643), reinforces the risks of relying on published guidance without detailed consideration. This was not an EIS case, but the principles are potentially relevant. Based on the court’s decision, it would be recommended that those seeking relief are aware: • of whether they are relying on guidance rather than the law • that relying on guidance which may later be held to differ from the law carries risks • that they should retain evidence demonstrating that they have relied on the guidance when they have done so • that even if HMRC’s guidance expresses a view which appears to be “clear, unambiguous and unqualified”, a court may take the view that it is not in a high degree unfair in the administrative law sense for HMRC later to depart from this view and apply the strict legal treatment. This makes for real risk where the rules are unduly complex, and strengthens the arguments for simplifying some aspects of the EIS regime to make this more transparent and straightforward for both issuers and investors. Market update / Impact of Rules Changes