8th July 2015
Jason Hollands, managing director Tilney BestInvest outlines his concerns about the tightening rules for VCTs and EIS.
No Budget is complete without some new meddling with the rules around tax advantaged venture capital schemes buried in the notes, and this Budget was no different.
In March 2015, the Budget contained proposals to tighten the rules around eligible investments for VCTs and EIS, primarily to ensure they complied with European State Aid rules. At the time HMRC set out a proposal to introduce a restriction on the age of a business that had not previously existed (to 12 years and 10 for “knowledge intensive companies”) and a new life time allowance for the overall level of tax advantaged funding that could be received of £15 million.
The proposed company “age limit” drastically scaled back further with investment now to be directed to companies within 7 years of their first commercial sale (10 in the case of “knowledge intensive” companies), clearly directing VCTs towards much earlier-phase businesses. Current VCTs have backed companies that were first set up decades ago, but have helped them, often under new management, to grow significantly.
Additionally, the “lifetime” limit for tax advantaged funding has been carved back from £15 million in March to £12 million as of today’s announcement (£20 million for “knowledge intensive” companies), an adjustment that might partially reflect exchange rate changes, since these rules are being driven by Europe.
In a subsidiary paper issued yesterday, HM Treasury has indicated that existing VCTs potentially may no longer be able to reinvest monies raised from exits in businesses that were previously eligible at the time of funding (such as a Management Buy-Out) into similar transactions. Therefore “grandfathering” of previous deal types looks set to end and therefore proceeds for exits will either need to be reinvested in companies meeting the new restrictions, or returned to shareholders as special dividends. When the Finance Bill is published next week we will get to know the finer details.
Additionally, there is a new proposal introducing greater restrictions on how monies are invested within a VCT’s non-qualifying portfolio, again potentially restricting support for MBOs.
In my view these are potentially problematic changes and VCT and EIS groups will be anxious to engage with HMRC on the details. The HM Treasury has stated they want to “ensure that the schemes target higher-risk companies”. The tighter requirement will inherently limit the range of investment opportunities available, so that may mean lower fund raising and more competition for deals.
This isn’t great news for long established, small companies with the scope to create jobs and wealth, who still need access to capital but will no longer be eligible for this form of financing because of greater restrictions. The age of company in itself has no relevance to a business’s funding needs or its scope for fuelling jobs and economic growth.
We were already expecting many VCTs to seek much more modest levels of new fund raising this tax year as a result of the previously proposed restrictions. It should be noted that on 20 May the Board of Northern Venture Trust chose to return cash to investors, citing a lack of new investment opportunities, adding in its stock exchange disclosure:
“Your directors are concerned that the investment rules are becoming steadily more restrictive, influenced by the European Commission’s views as to the type of business which should be eligible for investment by state-aided funds such as VCTs. We agree that financing should be readily available for start-up and early stage companies, particularly in knowledge-based industry sectors; however the increasing focus on such companies means that the VCT rules are becoming less friendly to many of the small and medium-sized businesses which have formed an important part of our investment activities in the past, and which have demonstrably made a substantial contribution to the economic well-being and growth of the UK.”
Potentially lower fund raising activity due to a narrower set of investment opportunities ironically comes at a time when potential demand for VCTs from investors might otherwise have been stronger than ever as a result of the reductions in the lifetime pension allowance and the tapering away of pension tax allowances for higher earners, confirmed in the Budget.