EIS 2018 report (web)

11 REGULATORY CHANGES GIVING TAX-EFFICIENT SCHEMES NEW LEGITIMACY Philip Hammond’s Autumn budget revealed two key changes for EIS. The first was the government’s support for innovative companies - with a strong bias towards bolstering the UK’s tech sector. This came in the form of increasing investment limits for knowledge-intensive companies (KICs) - an area which has been struggling to gain access to long-term capital. The second update is the implementation of a principles-based approach to test whether investments pose a “risk to capital” - i.e. whether capital preservation strategies are taking place. This has widely been seen as a systemic problem with EIS - with investment providers using the scheme as a mechanism for tax avoidance, rather than a genuine way to invest into growing UK companies. The two headline changes are not mutually exclusive. With the restrictions on capital preservation, there is hope from the government that more investment will be funneled into growing, innovative firms. RESPONSES TO THE PATIENT CAPITAL REVIEW In November 2016, the government launched its Patient Capital Review (PCR) with the aim to consider “how to support innovative firms to access the finance that they need to scale up”. 1 One year on and HMRC received 200 written responses to its PCR. Highlighted in the responses was the funding gap for pre- revenue and pre- profit firms - this was especially the case where companies had “delayed cash flows or significant product development time”. The main issue was in the area of follow-on investment, that firms needed in order to scale up. Respondents to the PCR saw the pain points being Series B to D investment, and investment sizes between £5 - 10m. KICs and technology companies were most acutely affected FUNDING CRITERIA SOURCE: EISA NO. OF EMPLOYEES TRADING FROM.. GROSS ASSETS OTHER SEIS FUNDING CRITERIA LESS THAN 25 <2 YEARS <£200,000 No previous investment from a Venture Capital Trust or EIS Subject to a lifetime SEIS funding limit of £150,000 COMPARABLE REQUIREMENTS FOR EIS LESS THAN 250 <7 YEARS <£15M £ Maximum lifetime amount that can be raised under SEIS, EIS, and Venture Capital Trust is £12m (£20m for ‘knowledge-intensive’ companies) SOURCE: EISA THE BENEFITS OF INVESTING THROUGH EIS AND SEIS % INITIAL INCOME TAX RELIEF CGT FREEDOM CGT DEFERRAL RELIEF LOSS RELIEF INHERITANCE TAX RELIEF EIS 30% Actual net cash outlay of 70p in the £ No capital gains tax to pay Potential unlimited and indefinite deferral of an existing CGT bill Maximum exposure of 38.5p in the £ for a 45% income tax payer Potencial saving of 40p in the £ SEIS 50% Actual net cash outlay of 50p in the £ No capital gains tax to pay Potential exemption of 50% of an existing CGT bill Maximum exposure of 27.5p in the £ for a 45% income tax payer Potencial saving of 40p in the £ by funding issues, as capital was readily available for companies with a proven business model. In terms of a critique of capital preservation, one response to the PCR revealed that 62% of the £743m raised by EIS funds in 2016/17 was targeted towards capital preservation strategies, whilst only 26% listed it as an objective. 2 Bruce Macfarlane, managing partner at MMC Ventures, explained: “Over half of the investments made via EIS funds to date have gone to funds that advertised a low-risk profile to their investors. This approach is not in the spirit of the EIS legislation, which was created to channel investment into young companies that create jobs and drive economic growth.” 3 A boost to Knowledge-Intensive Companies The government reacted to the results of the PCR in the Autumn budget and new rules applicable to KICs will come into effect on 6 April 2018 (subject to EU State Aid approval). MARKET UPDATE